Moral hazard occurs when one person assesses the risk of an endeavor and causes another person to bear the cost if things go badly. Borrowed money is inherently likely to produce moral hazard. Heads I win, tails you lose. Japanese banks forget normal placed restrictions on what borrowers could do with the loaned money and reduced or eliminated owner capital requirements. These banks loaned large sums of money, no questions asked. Investors in the bank had become careless about where they were storing their money. The depositors were not asking questions about the bank investment; instead, they were relying on the government to safeguard their investment. Bank Deregulation opened up more competition for public savings and increased freedom to make bad risk investments. Competition further eroded profit margins for banks to cling to old-fashioned ways of doing business. The bank loaned more and helped inflate the Japanese bubble economy. In 1990, the Bank of Japan raised interest rates and the air started to stream out of the bubble with land and stock prices dropping 60% below peak. “Japanese authorities seem to have regarded all of this as healthy-a return to more sensible, realistic asset valuations.” Instead a deepening economic malaise was setting in: unemployment hitting 10% and historical GDP contraction. Analyst called the phenomena a “growth recession”, “liquidity trap”, or “growth depression”. Japan manufacturers were increasing producing, inventories stock piling, and consumer spending lagging. Spending was not keeping up with production. In 1996, Japan’s Finance Ministry was running a 4.3% of GDP deficit. Japan was experience a baby bust and its working-age population were declining. The retired citizens were a heavy fiscal burden on the Japanese government. In 1997, Prime Minister Ryutaro Hashimoto increased taxes to reduce the budget deficit. The Japanese economy plunged into a recession. The debt to GDP ratio was 100% but the investors maintained faith in the long-term soundness of the Japanese government. The Japanese banking crisis paralleled the 1930-31 banking crisis inflicted by long-term damage to credit markets. Credit was not available, even when quality opportunities presented it. The market was starved for money. The eight-year stagnation was a time for repentance.[Learn More ...]

&Links