Topic 8: Condensed Flashcards
What was Japan like pre crisis (during the boom)
Credit to GDP rose sharply
GDP per capita rose sharply
Asset prices rose sharply
What was Japanese regulation pre boom
credit provision tightly regulated
prudential bank regulation
lending and deposit rates capped
firms need special permits to issue bonds
limits on international inflows and outflows
what was the japanese financial liberalization
Deposit rate caps abolished
restrictions on bond issuance abolished
limits on international flows ablished
what were the consequences of financial liberalization in japan
slow liberalization for savers meant that deposits remained a significant source of bank funding
faster liberalization for borrowers meant that large firms left banks for the bond markets and banks had to find other borrowers, which caused a rise in real estate loans and lending to smaller firms
overall increased lending in economy
what were the macroeconomic policies and dynamics in japan during boom
flexible exchange rate - high USD interest rates caused appreciation of USD vs JPY
Plaza accord -> agreement between G5 countries to depreciate USD, caused JPY to appreciate 46% vs USD
This caused japan exports and GDP to stop growing, which caused japan to cut rates by 3%, large fiscal stimulus, and GDP started growing again
what was the trigger of the japan crisis
increase in japanese rates in 1989
stock market fell 50%
commercial real estate fell 60%
financial accelerator ran in reverse
what happened to Japanese banks in crisis / how was crisis
took longer for bank failures to appear vs sweden, but crisis lasted longer and was worse
credit cooperations resolved, funds came from private banks and BoJ, solvent banks became concerned that their contributions could endanger their solvency
Jusen crisis: non-bank FIGs making loans, resolved, funds came from taxpayers -> public resentment
5 large banks resolved/recapitalised
capital injection by the state to recap
stabilisation measures in japan
debt guarantee for all banks announced in 1997
financial assistance package of 30tn, however banks were reluctant to apply for assistance in order to not be singled out
what was extend and pretend in japan
prudential regulation of banks capital was not enforced vigorously -> banks overstated capital to avoid issuing new equity by not acknowledging losses on their bad loans
possible reasons for non vigorous capital regulation in japan
lack of political will to commit taxpayer money to save banks
given limited funds, forcing banks to acknowledge losses on loans could lead to bank failures and panics
why is extend and pretend costly for the real economy
zombie firms less productive than healthy firms
they have no incentive to issue new equity and invest (debt overhang)
zombie firms crowd out healthy firms
receive subsidised bank loans, their bank capital was not available for loans to other firms, lower healthy firm profitability by competing with them in goods and labour markets
what was regulation like in sweden pre boom
credit provision tightly regulated by state
prudential regulation of banks (8% capital for corporate loans, 1-4% for mortgages depending on LTV)
bank holding of gov and MBBs must be greater than a certain fraction of assets
lending could not exceed a ceiling
lending and deposit rates capped
firms need special permits to issue bonds
limits on international flows
swedish financial liberalization
deposit rate caps abolished
liquidity ratios abolished
lending ceilings and lending rate caps abolished
limits on flows abolished
impact of financial liberalization in sweden
annual credit growth increased
bank employment increased
banks became more reliant on wholesale funding instead of deposits, increasing fraction of wholesale funding came from abroad
macroeconomic policies in sweden during boom
pegged but adjustable exchange rate
high inflation
central bank depended currency peg by keeping rates high
fiscal deficit until 1986
macro dynamics post liberalization in sweden
increase in credit -> increase in asset prices (fin acc)
increase in credit -> increase in AD -> increase inflation -> decrease in real rates -> increase in credit
increase in inflation -> loss of international competitiveness -> trade deficit
triggers of swedish crisis
increase in european interest rates due to german unification
fiscal tightening in response to high inflation
decrease in tax benefits of deducting interest payments from 50% to 30%
what happened to the macro in the crisis of sweden
GDP fell 1.1%
investment fell 9.8%
bank lending fell
real estate and stock market fell
what was swedish currency crisis
uncertainty about semi pegged rates ->speculative attacks on SEK ->swedish central bank hiked rates
fears that banks may not be able to continue borrowing internationally -> state provided debt guarantee for all banks
further speculative attacks on SEK -> this time didnt hike -> SEK devalued
high rates made banking crisis worse
davaluation hurt swedish frims borrowing in foreign currency
what was swedish debt guarantee
for all banks, goal was to ensure banks could continue borrowing and avoid runs
conditions -> only for solvent banks, state had to inspect banks, banks had to pay for cost of guarantee
there was limited use however - economy started to recover in 1993
what are the costs of regulation (pre lib) for both
Lending ceilings → Some positive NPV investments are not undertaken.
Lending ceilings → Banks have no incentives to raise their market share and design better products.
New institutional arrangements are created to circumvent the regulations
Non-regulated lenders have an advantage over regulated ones → Pressure to abolish lending ceilings.
similarities in boom japan vs sweden
Financial liberalization generated additional lending
Macroeconomic policies facilitated the credit boom.
Monetary policies:
Japan: Low interest rate limited the JPY’s appreciation.
Scandinavia: Pegged exchange rate.
what are the benefits of setting up a bad bank
Avoid extend-and-pretend.
Force banks to acknowledge losses on their bad loans.
Banks can otherwise roll-over bad loans to zombie firms.
Avoid fire-sales.
Assets are not sold at depressed prices.
Assets can be sold slowly, as economy begins to recover.
Exploit economies of scale.
Manage many similar loans.
Coordination between lenders is easier when there is only one lender
Better incentives.
Employees at the bad bank: Acknowledge that loans are bad, and maximize
revenue from managing them.
Free up bank capital for loans to new firms.
similarities in crisis and clean up between japan and sweden
Similarities:
One-off measures at early stages of the crisis.
More systematic and drastic measures at later stages.
Debt guarantee.
Sharp increase in funds made available by the state
