October 26, 2009 09:59 AM EDT by Elizabeth MacDonald
Is the U.S. now trapped in a zombie decade much like what Japan endured in the "?90s?
Answer: Yes, and the government will be conducting fiscal stimulus and deficit spending for five, perhaps 10 years, to revive the economy.
And did you know that seven out of eight U.S. banks were actually bankrupt due to the Latin American banking crisis of the early "?80s? And that printing money won't fix the problem?
That's the word from Richard C. Koo, a renowned chief economist of Nomura Research Institute and former economist at the New York Federal Reserve in the early "?80s.
Koo noted all this in a speech entitled "Great Recessions: Lessons Learned from Japan" to the Center for Strategic & International Studies late last year.
"People should know what kind of disease [the U.S. economy] is stuck with," Koo says, adding the government should be clear about telling the taxpayers and consumers this is a balance sheet recession, and the length of time it will take to fix it.
A Time For Leadership
But you don't see that straight talk, that leadership. Instead you see more money tossed at housing bailouts to consumers living on the edge who should be renting instead of borrowing, bad loans that will only create more writedowns for banks down the road.
And you see at least $639 million in taxpayer money wasted on 93,000 homebuyer tax credits (at $8,000 apiece), given to scamsters, including a four-year old child.
No-Doc Tax Credits for No-Doc Loans
Government officials say little documentation is required for these credits, so no-doc credits are given to fix a crisis partly exacerbated by no-doc loans. A free-money free for all, paid for by U.S. taxpayers, as the annual deficit, once health care reform is factored in, will surpass $2.4 tn every year for the next ten years, more than the annual GDP of Russia.
This open fire-hydrant of taxpayer money pointed at reckless borrowers who basically just create more bank writedowns is now splashing full circle. Bailing out bad borrowers now threatens to permanently cement in stone the TARP bailout funds for the banking sector in the government's architecture.
Do taxpayers want TARP as a permanent fixture on the government's landscape?
Turning to Japan, you'll be surprised to hear what triggered the crisis in Japan, which also is just coming out of a deep balance sheet recession with massive writedowns. What ignited the crisis in Japan?
"Commercial real estate prices collapsed and housing prices went down" too, Koo says, adding that prices dropped 87% in Japan. Although the reverse happened here, what Koo says next is chilling. "Just imagine commercial prices down 87%" in the U.S., "that's what we suffered in Japan," he says.
Japanese banks lost nearly $1 trillion over the last 15 years, he adds, which U.S. banks are already set to surpass. Commercial real estate Kryptonite is just now beginning to cause regional banks to crater here, with major money center banks struggling with bad commercial real estate loans as well.
Can Government Spending Fix this Mess?
Koo warns that fiscal stimulus acted like a sugar high in Japan, where the Liberal Democratic party enacted eight stimulus packages between 1992 and 1999. Each time the packages wore off, though, the Japanese markets reacted violently.
But without the spending, Japan would have lost 75% of its GDP, Koo says, adding, "I am no great fan of fiscal stimulus," but that such spending can work, especially when an economy is dealing with deflation, massive debt, and damaged balance sheets at households and companies.
Devaluing Our Way Out of the Crisis
Now the policy in the U.S. is to devalue and inflate its way out of the crisis, as the word out of Washington officials such as Treasury Secretary Tim Geithner is that a weak dollar will not only help create more exports, but will restructure the economy permanently towards exports and away from consumer spending, now 70% of GDP, as households remain overleveraged and unemployment hits 26-years highs.
But in a weak dollar regime, capital flows surpass trade flows, and jobs will continue to flow offshore, economist David Malpass notes, as a weak dollar has U.S. companies setting up shop overseas and funneling profits back stateside. Profits earned in other currencies look massive when reported in a weak U.S. dollar regime.
Also, emerging markets such as Brazil, Russia, India and China combined represent just a third of the GDP of the U.S. and Europe, plus one-fourteenth of the consumption power of America and Europe. It's more than a faith-based initiative to think exports to these countries will revive the U.S. economy.
And if a weak currency were the way, as John Tamny of RealClearMarkets notes, Argentina would be an economic powerhouse. And to which I would add Zimbabwe would be a superpower.
The U.S. Has Been Here Before
Koo also said the U.S. has been in a severe banking crisis before, and he's not talking the Great Depression. He said that U.S. banks have been bankrupt throughout the nation's history "”although the general population didn't know it at the time.
Specifically, Koo said that the New York Fed concluded that the Latin American crisis of 1982 was the worst bank crisis in modern U.S. history.
"Our conclusion was that seven out of eight U.S. money center banks were actually underwater," because they were overexposed to Latin American banks, Koo says, adding "everyone from Mexico to the southern point of Chile went bankrupt."
The U.S. went into action. Fed Chairman Paul Volcker importuned foreign banks, including Japanese banks, to keep their credit facilities wide open to U.S. banks in order to avoid a wholesale collapse in the banking system, "knowing full well these American banks were bankrupt," Koo says.
But, "we could not tell the outside world how bad the situation" was, Koo adds.
And Volcker ordered U.S. banks in 1982 to keep lending to "Mexico's dictators" and banks, so its banks didn't completely fall into the drink, dragging U.S. banks with them, as they were already "underwater" and near "collapse," Koo says.
Koo says that the Fed knew at the time that U.S. banks were "bankrupt," but could not publicly discuss how bad the situation was, because "the next day they would be bankrupt" due to a run on the banks.
Koo says that instead Fed officials concocted a party line that the banks were dealing with "good debt on their books."
[Recall what then Treasury secretary Henry Paulson advised in not telling the market in the fall of 2008 about the government's lack of resolution authority to save Lehman Bros. from collapse, "you don't want to say the emperor has no clothes."]
Koo says it actually took the Federal Reserve 13 years to fix the U.S. banking system's dangerous exposure to Latin American debt crisis, adding that Volcker created a steep yield curve, just as the central bank is doing now, letting U.S. banks keep loan rates high, while short-term rates were kept low.
That cash flow from this "fat" spread helped banks cure their sickly balance sheets. Doing so also prevented costly taxpayer bailouts "” to the point where very few people were aware of the severity and serious dangers of the Latin American banking crisis, and the bankruptcy of U.S. banks at the time, Koo says.
"Americans only remember the S&L crisis," when the Latin American debt crisis was "ten times larger than the S&L crisis," Koo says.
"Print the Money!"
Koo also says that that economists Paul Krugman, Milton Friedman, Ben Bernanke, "all travelled to Japan and bashed Japan left and right," adding they exhorted Japan "to just print money and everything will be fine" to get out of its crisis.
Even former Fed chairman Alan Greenspan was saying, "just print the money'" in Congressional testimony, Koo says. "Japan can print all the money it wants," these officials chided Japan.
"But when you think about it, monetary policy is useless when no one is borrowing money, even at 0% interest rates," Koo says, despite economists who fervently believe monetary moves can solve all problems.
Koo says he even debated Krugman on this point for two hours for a Japanese magazine.
"He kept on pounding this point: "?Just print money, just print money, just print money,'" Koo says, "and I said 'No, it won't circulate because no one is borrowing money'" at a time when they are trying to repair damaged balance sheets, so "such monetary policy is ineffective."
True, too, as U.S. banks now refuse to lend this money, and are instead hoarding it to fill balance sheet potholes blown open by bad assets "” and also are using it to fuel the bond trading desks at Goldman Sachs and JPMorgan Chase, which are making money hand over fist due to the Treasury's massive debt financing, $3.5 trillion to date.
"Don't' put your hope on Mr. Bernanke," Koo says.
Name* required
Email* required * not displayed
Comment
Liz, You had it gauged right. What should have been done was to bring rules into the financial system instead of unertaking the socialistic takeoverof 1/7th of the national economy. On top of that, dumping nearly a trillion dollars to stimulate the economy has done quite the opposite in increasing unemployment and shrinking GDP. What happened to the capitalist country I remember? BobH
On the housing topic,renting is a good idea for many people. Although, for those who can afford a down payment, upkeep, and mortgage payments - buy - never rent. You are throwing money out the window! In most areas of the country, you can find a home for an affordable price. Finding a place to call "home" is both sentimental and practical. I feel everyone needs a place to settle down and live a lovely life. I would never disparage a person who receives a government loan is good faith.
Read Full Article »