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Tuesday, Nov. 11, 2008

Laissez faire has taken a powder


In the wee hours of Oct. 11 Tokyo time, finance ministers and central bank governors of the Group of Seven industrialized countries met in Washington to discuss how to resolve the global financial crisis and agreed to protect all depositors and inject public funds to rescue financial institutions.

The accord was welcomed by stock exchanges worldwide and share prices soared, but this trend proved short-lived as market volatility continues.

When Japan was hit hard by a serious downturn after the economic bubble burst in 1990, Yoshikazu Miyazaki, economist and professor emeritus of Kyoto University, stated that the nation was not facing a simple recession that could be cured by inventory adjustments, but rather a "compound recession" that required the disposal of assets deemed "nonperforming" following the sharp declines in land and stock prices.

Even though this theory was dismissed by a majority of mainstream economists as unsubstantiated, then Prime Minister Kiichi Miyazawa fully understood what the professor was preaching.

In the summer of 1992, Miyazawa sounded out the Federation of Economic Organizations, or Keidanren (which in 2002 became the present Japan Business Federation, or Nippon Keidanren), with the idea of spending public money to buy bad loans held by banks. The idea was not received favorably by Keidanren, which, as an organization primarily representing the manufacturing sector, could not accept injecting taxpayers' money to rescue the financial industry whose top executives were among the highest-paid in the nation.

Moreover, most of these business leaders were thinking the same way as mainstream economists, and took the recession lightly.

There is no doubt that early detection and early treatment are the best means of curing an economic disease. During the administration of Prime Minister Keizo Obuchi (July 1998 to January 1999), the government poured in huge sums of public money to buy up bad loans held by banking institutions. The Long-Term Credit Bank of Japan and the Nippon Credit Bank were nationalized temporarily before being returned to private investors. They became Shinsei Bank and Aozora Bank, respectively. These steps served to avert a meltdown.

The current international financial crisis was triggered when major banks, securities firms and insurance companies worldwide rushed to buy securitized subprime housing loans. As housing prices declined, the securities went sour and the financial institutions saw their liabilities massively exceeding the value of their assets — as Japanese financial institutions experienced in the postbubble recession.

But there is a difference. Whereas the real estate-secured loans that went bad in Japan were held entirely by banks, the securitized subprime loans — so deftly designed by financial engineers — circulated throughout the world, raising fears of a global depression.

The governments in Europe and the United States should be given credit for responding quickly to the crisis, but it is still too early to tell whether the desired results will be attained. Judging from U.S. government data, it seems obvious that the collapse of the financial market is having adverse impacts on the real economy. Sharp declines in U.S. personal consumption have begun to play havoc with the Japanese economy, which is heavily dependent on exports to America.

The quarterly survey of business sentiment published by the Bank of Japan on Oct. 1 showed a negative diffusion index for the first time in five years. A similar impact is being felt in China.

Rescuing banks from bad loans does not eradicate the fear of a spreading global recession. There is no guarantee that the real economy will recover soon even if the collapse of the financial economy is averted. What is essential to preventing an economic meltdown is to revitalize domestic consumption by extending help to people in the lower-income brackets.

A government's purchase of a majority of bank-issued preferred stock shares is tantamount to bank nationalization. If that continues for long, it will run counter to the fundamental principles of the capitalist economy and give birth to a new system that could be called financial socialism.

The next question is, who will buy the nationalized American and European banks once the crisis is over? It will be difficult to find corporations in the U.S. or Europe with the financial resources to do so. That will make it quite likely that purchase bids will come from oil-rich Middle East countries, India, China, Russia and other emerging economies.

It would be self-contradictory for the American and European countries, which have preached the merits of the market economy, to keep banks under government ownership. If financial institutions suffering from uncertainties are nationalized and their risks shifted to the government, it will mark none other than a fundamental revision of the market-economy system.

I call upon the worshippers of the free and competitive market economy to recognize that a pure market economy is not capable of removing instability and imbalance, and to learn from the current crisis what regulations should be imposed on the financial markets.

I also call upon policymakers to take expeditious action after recognizing that the laissez-faire attitude is coming to an end for the second time in history.

Takamitsu Sawa is a professor at Ritsumeikan University's Graduate School of Policy Science and a specially appointed professor at Kyoto University's Institute of Economic Research.


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