Echoes of Japan's "lost decade" rattle U.S. market

By John Parry - Analysis

NEW YORK (Reuters) - The course of U.S. financial markets over the last year reminds veteran investors of the early days of Japan's economic bust, but faster responses to the problem by the Federal Reserve and U.S. banks should help avert a full-blown U.S. version of Japan's "lost decade."

Key similarities between the U.S. story now and Japan's nearly 20 years ago -- plunging government bond yields, a cratering real estate market and a debt-burdened banking sector -- cannot be dismissed lightly.

Such signs make it likely that some kind of "Japan lite" scenario will play out with U.S. economic and asset growth grinding to a standstill, albeit for a shorter time.

The comparatively fast reactions by the Fed, which has cut benchmark lending rates by 225 basis points since September, and by U.S. banks, which have written off more than $70 billion in bad debt, signals to many that investors here need not fear a Japan-style recession.

"I don't see that happening here. I think we will see a much more normal market pattern," said Hugh Patrick, director of the Center on Japanese Economy and Business at Columbia Business School in New York. "The U.S. economic system is much more flexible and adaptable and monetary policy won't have to go as far as it did in Japan," he added.

After Japan's stock and real estate markets slumped starting in early 1990, the central bank delayed cutting rates for almost 18 months and then stretched its easing cycle over nearly five years. Japanese banks, meanwhile, steadfastly refused to recognize their soured loans. The two factors conspired to prompt a decade-long recession.

"On the monetary policy side you definitely had a Bank of Japan, which at least in retrospect, was slow to act," said Leo Kropywiansky, Japan economist at Putnam Investments in Boston.

It took the Bank of Japan until 1995 to reduce its overnight lending rate to below 0.5 percent from the 6 percent level at the start of the crisis. Contrast that with the Fed, which has slashed borrowing costs since September when it began lowering the Federal Funds rate from 5.25 percent to the current 3 percent.

"Right now we are getting quite a rapid response by the Fed," Kropywiansky said.

Also helpful is that Wall Street banks have been comparatively aggressive in writing down bad debts from the housing slump and just as quick to replenish depleted capital. Sovereign wealth funds have invested more than $30 billion in U.S. banks since October.

"The U.S. banks are being quick to tap in foreign capital and bring it in very aggressively," Patrick said.

By contrast, Japanese bankers' close relationships with customers restrained many from executing mortgage foreclosures and writing off bad debts. Resistance from branch managers stymied efforts by central offices to clean up the books.

"In Japan, the central hierarchy back in head office didn't have any real authority to pull the trigger until the late 1990s," said Charles Whitehead, associate professor of law at Boston University School of Law. "That's one big difference."

This aggravated a huge non-performing loan problem, and losses ultimately totaled about 20 percent of Japan's gross domestic product, according to Richard Katz, editor of the Oriental Economist newsletter. Even if the total cost of the current U.S. housing crisis reaches about $500 billion, doubling some current estimates, that would still be just 4 percent of U.S. GDP, Katz expects.

Japan's "non-performing loans problem started to appear in the early to mid 1990s and by 2002 was it very clear the problem was not being solved," said Patrick. "Finally they injected government and private capital," he said.