1. Two Generations of Asset Price Bubbles: From 1990 Japan to 2007 U.S. Eric Rashi

2. What are Asset Price Bubbles? 0 An upward price movement over a period of time, unexplainable based on fundamentals, and which eventually implodes 0 Implosion associated to widespread socio-economic distress 0 Not a new phenomenon: 0 Irrationality: mania 0 Human psychology 0 Market manipulation

3. New More Modern Causes Globalization New Financial Architecture Policy Mistakes 1 2 3

4. The Current Problem 0 “Greenspan” principle: policy-makers should not intervene in the markets to prevent bubbles, only clean up the mess once they burst BUT… 0 Bubbles are very dangerous: history of leading to banking crises 0 Japan 1985-1990  “Lost Decades” 0 U.S. 2003-2007  Global Financial Crisis

5. Japan: From Asian Miracle to “Lost Decades”

6. Japan Real Estate Bust… 0 1990 real estate bust put pressure on banks’ balance sheets

7. Coupled with Equities Bust 0 Full-blown banking crisis: 0 1992-1998: 21 Big Banks write of ¥42.02 trillion of bad loans 0 Peak capital base during time period was only ¥22.15 trillion in 1994

8. Causes of Japan’s Financial Bubbles From controlled to competitive market-based system Banking liberalization Financial engineering (zaitech) enabled speculation Financial innovation Cheap credit and high liquidity Prolonged monetary easing

9. Japanese Government Response 0 Underestimated crisis: too little, too late: 0 Long-term measure: provide subsidies to failing banks

10. 2008 U.S. Crisis : Similar Story?

11. Spread to Real Economy 0 Full-blown banking crisis: heavily exposed banks are acquired or collapse

12. Causes of U.S. Housing Bubble Greenspan led deregulation: Gramm-Leach-Bliley Act 1999 Banking liberalization Mortgage market securitisation: tranching, CDOs, MBS, … Financial innovation Cheap credit and high liquidity after 2001 dot-com bust Prolonged monetary easing

13. U.S. Government Response 0 Immediate and aggressive 0 Pushed for “private sector solution” amongst banks

14. Main Takeaways 1) The Japanese and U.S. episodes are strikingly similar 2) Bubbles, particularly in real estate, can pose a serious threat to the real economy 3) “Greenspan principle” seems outdated:  Policy-makers need to contain spillovers (ex-post)  Also need to act proactively (ex-ante)

15. Preventing Future Asset Price Bubbles Continue with efforts: Basel III and U.S. Dodd-Frank Act Re-regulation Understand complex products and reduce systemic risks Keep up with financial innovation Monitor real estate prices and avoid low interest rates Conservative monetary policy

16. Response to Future Asset Price Bubbles 0 U.S. response was more successful in containing damage from housing collapse and in returning economy to growth: 0 Must act quickly and aggressively 0 Must protect banks

17. Difficulties to Overcome 0 Preventing and reacting to bubbles is not an easy task: 1) Bubbles are difficult to establish ex-ante 2) Reputational difficulties for policy-makers 0 But… given the threat, these difficulties must be overcome...

18. Questions?

19. Bubbles: difficult to establish ex-ante

20. U.S. Loan Delinquency Rate (% of total)

21. U.S. Gross Public Debt (% of GDP)

22. Japan Public Debt (% of GDP)