Conference on “The Global Crisis and Reform of International Financial Architecture” June 2009, Beijing Comment on “Will the U.S. Bank Recapitalization Succeed? Lessons from Japan” by Takeo Hoshi and Anil Kashyap Dong HE Hong Kong Monetary Authority and Hong Kong Institute for Monetary Research

What does the paper do? Describes the Japanese experience in asset purchase and recapitalization programs Draws lessons from the Japanese experience Evaluate the U.S. TARP and CPP in light of the Japanese experience

What does the paper say? (I) “The Japanese experience suggests that the purchase of non- performing loans did not solve the capital shortage problem; It is possible that a much bigger, comprehensive program might have eliminated the uncertainty of the value of assets that remained on banks’ balance sheets and allowed them to find willing investors to contribute new capital. But, because none of the Japanese AMCs were designed to overpay for the bad loans, just removing some of the assets did not rebuild capital.”

What does the paper say? (II) “The main problem with the Japanese approach was that the banks were kept in business for far too long with insufficient capital. This limited banks willingness to recognize losses and they took extraordinary steps to cover up their condition and in doing so retarded growth in Japan” (italics added) “…in the Japanese case the performance of the aggregate economy was paramount in the recovery of bank capital”

What does the paper say? (III) “As in the recent Japanese financial crisis, the shortage of capital [in the U.S.] is the fundamental problem that must be fixed. Japan teaches us that challenges related to capital injections differ somewhat from the challenges related to asset purchases. Inducing banks to participate is one factor. It is also critical to make sure that enough money is spent so that banks actually emerge adequately capitalized. Finally, care should be taken not to waste money propping up financial institutions that will ultimately fail.”

An informative paper Very clear description of the Japanese experience Unequivocal lessons Agnostic about the likely outcome in the U.S.

A few questions Asset purchase vs recapitalization: do they serve different purposes and therefore should be pursued simultaneously? Apples and oranges: was the nature of the two banking crises different, since the crisis in Japan took place much later in the housing price cycle than in the U.S., i.e., after 7 years of house price declines in Japan as compared to one year of price decline in the U.S. A chicken and egg problem: main stream economists don’t believe the U.S. economy will start a sustained recovery until banks are adequately capitalized. Does the Japanese experience show that the banks will not become properly capitalized unless the economy starts to recover?

Asset purchases vs recapitalization The market for lemons Seniority of claims and “loss sharing” Pro-cyclicality of capital regulation

Apples and oranges?

Iliquidity or insolvency? If the stress test results of U.S. banks were credible, then it appears that the U.S. financial crisis was hardly a crisis of insolvency Was it simply a liquidity crisis in the banking sector, plus a typical recession induced by the oil price shock (James Hamilton 2009)? The path of recovery of the global economy critically depends on this judgment

Summary A very informative and thought-provoking paper Important questions still remain regarding how relevant the Japanese experience is to the resolution of the crisis in the U.S. Would the U.S. housing prices continue to decline for another ten years, in which case we can expect that the Japanese experience will become increasingly relevant?