Growth & Crises Michael Smitka Fudan University 復旦大學 November 2000

Overview - why so few crises? Leverage is dangerous! Banks avoid crisis using rules of thumb Those rules work - most of the time

Why then crises? Change undermines rules of thumb –Change in types of industry / borrowers –Change in strategic environment / flow of funds –Change in regulatory environment Mistakes are made … –… and a shock produces crisis

Remedies? Regulators face a new structure –They work by rules-of-thumb, too –And have the same history An AMF role? –Experience beyond one economy’s limits –But would their advise be taken? –Even once would repay the effort!

Japan’s Case No need for financial controls –project selection was easy –failure was hard / recessions were few & far between But pricing long-lived assets was hard –Real estate grew faster than economy –Stock prices grew faster than economy –Growth industries grew very fast indeed!!

Growth Dynamics Transition out of agriculture –Fast productivity growth in industry –Urbanization! Household formation Infrastructure, housing But it’s a one-time transition! –And eventually ends

Slowdown Industry no longer needs funds But households keep saving –Past savings was at low income levels –So accumulated wealth is modest –Need to keep saving to fund old age Who then will borrow?

Shifts in Japanese Savings Flows

The Primary Shock: 1970 vs 1976 Corporate investment fell 10% of GDP Savings rose! Banks were left to scramble

Interregnum Japanese fiscal deficits –created a new borrower for banks –MOF policy stopped that by 1982 Reagonomics: US consumption boom –Export-led growth from 1982 –Appreciation / Plaza Accord stopped that from 1986

Secondary Shock Bad macro policy –Easy money from 1986 –“Japan as Number One” psychology Just as banks sought new borrowers –Real estate … and more real estate! –Small business –Also international loans

Shocks, continued “Bubble” economy –Stock prices doubled –Urban real estate prices rose even more Fiscal policy mistakes accentuated –On-again, off-again policy built up debt Regulatory policy errors accentuated –Banks allowed to make more bad loans

Lessons Long-lived assets easy to mis-price –Stocks –Real estate Outside nay-sayers may be right Rapid growth creates pressures that virtually promise crisis

But crises may be inevitable Even the slow-growing US suffered –Interest rate shocks undermined S&Ls –Regional growth led to real estate bubbles –A new venture, international lending, proved disastrous (esp. to borrowers) And now deregulation … –Loan quality falling in a boom economy

The End Until leverage strikes again –Deregulation is no panacea –Regulation fares no better