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Japan, Sweden may offer economic recovery lessons

  • Story Highlights
  • Japan and Sweden struggled through financial crises during the 1990s
  • Both crises involved banks that were crippled with bad loans
  • In both cases, governments took extensive action to help banks recover
  • Economists: The U.S. crisis is unique, but there are lessons to be learned
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By Manav Tanneeru
CNN
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(CNN) -- As President Obama discusses the economic crisis with world leaders at the G-20 summit this week, two nations' experiences wrestling with similar financial troubles in recent history could offer recovery lessons for the United States.

President Obama is discussing the global economic crisis with other world leaders at the G-20 summit this week.

President Obama is discussing the global economic crisis with other world leaders at the G-20 summit this week.

The current financial crisis roiling the U.S. and global economies is unique, but the crises that plagued Japan and Sweden during the 1990s -- and their different solutions to the similar problem -- offer a kind of parallel in history.

In both countries, real estate, stock and asset bubbles burst, leading to failed banks, economists and observers say. Their respective economies declined dramatically, and in both cases the national governments eventually had to take extensive action.

Japan's 'Lost Decade'

Japan's financial troubles in the 1990s -- dubbed the "Lost Decade" -- had their roots in the booming 1980s, when real estate prices skyrocketed. That bubble eventually burst, in part because of a rise in interest rates.

"What we know is that whenever we see the extraordinary rise of stock prices or land prices, those are usually followed by a collapse," said Takeo Hoshi, an economist at the University of California, San Diego. "That happened in Japan and that happened in the United States."

Similar to U.S. banks' struggles through the current crisis, Japanese banks that had given out loans during the boom based on overvalued real estate found themselves in a lot of trouble.

"In both cases, it was a huge asset bubble in real estate and stocks, which was caused by easy credit and excessive liquidity, added to bankers' arrogance, reckless lending and lax oversight," said Jeff Kingston, a professor at the Japanese campus of Temple University. "In both cases, they were accidents waiting to happen."

Faced with a stagnant economy, failing financial institutions and a growing credit crunch, the Japanese government over time lowered interest rates to revive the economy. That didn't work; critics say Japan didn't lower rates quickly enough.

Next, hoping to stabilize banks with infusions of capital, Japan pushed through several bailout packages, which cost trillions of yen, or tens of billions of dollars, during the 1990s. That didn't help much either.

Things didn't get better until late 2002 when Hiezo Takenaka, a Cabinet-level government official, aggressively took on the financial industry. "That was the turning point for Japanese financial policy," Hoshi said.

Takenaka rigorously inspected the banks' balance sheets, disclosed their debts publicly to ensure transparency, and forced them to write off their bad, nonperforming loans.

"He did that without taking over the banks. At the same time, if some banks turned out to be insolvent, he was ready to take over those banks," Hoshi said.

For example, the government injected capital into Resona Bank, became its majority shareholder and changed the management after it was found to be nearly insolvent. "It was a de facto nationalization," Hoshi said.

During the next few years, a majority of the banks cut their nonperforming loans and, coupled with a rise in exports to countries like the U.S. and China, the Japanese economy began to recover, Hoshi said.

The Swedish case

Just as Japan was heading toward a financial meltdown in the early 1990s, Sweden was about to confront its own crisis.

Banks lent freely during a 1980s boom, which caused real estate prices to rise, said Giovanni Zanalda, a Duke University professor currently teaching a course on financial crises through history.

Many Swedish banks, as a result of deregulation of the financial sector, engaged in heavy lending during the boom. When the bubble burst in 1991 they were saddled with vast amounts of bad debt. Three major banks eventually collapsed, Zanalda said.

However, the Swedish response was quick and aggressive.

"They just grabbed the whole thing immediately and began to work through the issues purposefully through the government," said Peter Rodriguez, an economist at the University of Virginia. "They did not even really presume to try free-market solutions."

In late 1992, the government guaranteed the debts and deposits of all Swedish banks, forced them to write off their losses and bailed them out when needed.

The government also nationalized the banks to relieve them of their bad debts. Effectively, Swedish banks were forced to separate their healthy assets from their bad ones, Zanalda said.

These bad debts were then placed in an entity -- what is typically called a "bad bank." Since these bad loans were no longer on the banks' asset sheets, they were free to resume lending. Once they were healthy again, banks were returned to the private sector.

Meanwhile, by 1997, as the economy recovered, all the assets that were in the "bad bank" were sold off.

Lessons learned

Despite substantial differences in the nature of the U.S. crisis and what happened in Japan and Sweden, those crises provide some helpful insight for American policymakers, experts said.

"I think the big lesson is [not to] wait to make all the hard choices," Kingston said. "Bite the bullet at the outset and try to get it over with. It'll cost you a lot less in the end."

In March, the Obama administration detailed its plan to rescue U.S. banks. Since the announcement, a debate has begun over whether it is aggressive enough to help hasten an end to the banking crisis. Video Is the bank rescue plan working? »

"It is aggressive, but probably not enough. Think of it as a sizeable down payment on trying to strip out the toxic assets, which is a key step forward," Kingston said.

He said additional public funding may be necessary to further stabilize the banks, but the public mood may be against it.

"In Japan, too, there was a strong public reaction against the bailout that made politicians wary of doing what needed to be done, prolonging the problem," he said.

Some economists said the primary lesson from the two crises was the importance of maintaining confidence in the system. "There's no easy way to do this other than getting rid of the nonperforming loans from the system," Hoshi said.

Whatever the means used to rescue the banks -- whether it is nationalization or letting the free market decide their fate -- Rodriguez said the Japanese and Swedish crises showed clear, decisive action was key.

"As far as we can tell, this particular situation won't tolerate leaning in the middle," he said.

Why the U.S. case is unique

However, experts caution that the size and scope of the U.S. economy make its financial crisis unique.

"This is the world's largest and most integrated economy floundering," Rodriguez said.

Unlike the U.S. situation, the Swedish government had a financial stake in the major banks even before the crisis set in, according to a 2008 U.S. congressional report titled the U.S. Financial Crisis: Lessons from Sweden. Additionally, the loans that eventually soured were nearly all held within the country, so there wasn't a global dimension to the crisis.

There are equally important differences between the Japanese and American crises.

Richard Katz, in the recent issue of Foreign Affairs magazine, wrote that the comparison was wrong for two reasons.

"[The U.S.] financial dysfunction is not the result of structural flaws, as in Japan, but of grave policy mistakes," he wrote, referring to lax regulation of subprime mortgages and the banking system as a whole.

He also pointed out that the American response has been quicker, noting that it took the Bank of Japan nearly nine years to reduce the overnight interest rate (the rate at which the central bank lends to other banks) from a peak of 8 percent to zero. In the U.S., the Federal Reserve took only about 16 months, beginning in August 2007, to bring that rate from 5.25 percent to zero, Katz wrote.

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Katz, also the editor-in-chief of the Oriental Economist Alert, argues that Washington has been quicker to bail out the banks with taxpayer money, something that Japan did not do for years.

"There is absolutely no need for fatalism or talk of an upcoming 'lost decade' in the United States," Katz writes. "Bad policies created this mess. Better policies can fix it."

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