Friday Night Zombies

Since people are worried about the creation of zombie banks here in the US, lets have a couple of articles about the zombies in Japan during their "Lost Decade".

Zombie Lending in Japan /Research by Anil K Kashyap

However, the political and regulatory response to the financial crisis [in 1990's Japan] was to deny the existence of the problems and delay serious economic reforms or restructuring of banks. Because banks had to comply with international standards governing their minimum level of capital, many banks continued to extend credit to insolvent borrowers, gambling that these firms would recover or that the government would bail them out. The Japanese government also encouraged banks to increase their lending to small- and medium-sized firms to ease the �credit crunch� after 1998.

The pattern of Japanese banks lending to insolvent borrowers, even when the prospects for being repaid were extremely doubtful, has been termed �ever-greening� in previous research. The practice of ever-greening became even more pervasive in the late 1990s and early 2000s.

In a new study �Zombie Lending and Depressed Restructuring in Japan,� University of Chicago Graduate School of Business professor Anil K Kashyap, Takeo Hoshi of the University of California at San Diego, and Ricardo J. Caballero of Massachusetts Institute of Technology explore the role that misdirected bank lending played in prolonging Japan�s economic stagnation. The authors focused on the widespread practice of Japanese banks lending to unprofitable borrowers that the authors refer to as �zombies.�

More on that study here:

In this paper, we propose a bank-based explanation for the decade-long Japanese slowdown following the asset price collapse in the early 1990s. We start with the well-known observation that most large Japanese banks were only able to comply with capital standards because regulators were lax in their inspections. To facilitate this forbearance the banks often engaged in sham loan restructurings that kept credit flowing to otherwise insolvent borrowers (that we call zombies). Thus, the normal competitive outcome whereby the zombies would shed workers and lose market share was thwarted. Our model highlights the restructuring implications of the zombie problem. The counterpart of the congestion created by the zombies is a reduction of the profits for healthy firms, which discourages their entry and investment. In this context, even solvent banks do not find good lending opportunities. We confirm our story's key predictions that zombie-dominated industries exhibit more depressed job creation and destruction, and lower productivity. We present firm-level regressions showing that the increase in zombies depressed the investment and employment growth of non-zombies and widened the productivity gap between zombies and non-zombies.

A similar result was obtained by Alan G. Ahearne and Naoki Shinada:

It is often claimed that one contributing factor to Japan's weak economic performance over the past decade is that Japanese banks have continued to provide financial support for highly inefficient, debt-ridden companies, commonly referred to as "zombie" firms. Such poor banking practices in turn prevent more productive companies from gaining market share, strangling a potentially important source of productivity gains for the overall economy. To explore further the zombie-firm hypothesis, we use industry- and firm-level Japanese data and find evidence that productivity growth is low in industries reputed to have heavy concentrations of zombie firms. We also find that the reallocation of market share is going in the wrong direction in these industries, adding to already weak productivity performance. In addition, we find evidence that financial support from Japanese banks may have played a role in sustaining this perverse reallocation of market share.

Interesting.  To bring an analogy closer to home, the issue would not be that CitiGroup has become a zombie; the issue would be that, in order to avoid booking an unacceptably high level of losses on its loans to General Motors, Citigroup is making new loans to the zombie GM rather than to potentially profitable firms that might otherwise emerge to compete with GM.

Put that way, how worried should we be that Citigroup will double down on its home mortgage loans while ignoring other lending opportunities?  We might also take encouragement from the thought that the US capital markets are much more developed than those of Japan - the commercial paper market, the private placement market, andf the market for public debt all allow borrowers to bypass bank lenders.

Right now Geithner is just muddling through, which is not encouraging.  But the US ought to be better able to muddle through than Japan was.

[End of Thread]

Comments

[bad]

Geithner sucks

[hit and run]

Geithner, Zombie Treas Sec

[bad]

Happy VD

[daddy]

Bad thou art bad! But funny.

[bgates]

how worried should we be that Citigroup will double down on its home mortgage loans while ignoring other lending opportunities?

If the next $900 billion in loans are going to DC, and the generational theft act lives up to the promises of saving 4 million of the 137 million jobs in the country, could I ask, "what other lending opportunities?"

[Alan]

It takes a lot of political courage to let go of zombie banks and firms. This is a case where we all know what needs to be done thanks to experiences in other countries. But the question is : are we willing to go through the pain in order to make the restructuring ?

[jimmyk]

Hey, do I get a h/t here? :) My comment in the "Can We Handle the Truth Thread" (as I don't know if the linky thing will work, so here it is):

And that's the problem with all these prog rules: lenders will no longer be able to get hands on their security while it is worth anything, and without excessive transaction (legal) costs.

That's right, and in addition, it's going to delay the ultimate resolution of uncertainty about the value of what's on bank balance sheets. Many of these borrowers will default anyway, but this will just prolong the agony. In the meantime we will have both zombie households and zombie banks.

[PeterUK]

Surely this is covered by equality laws? Banks have to lend to Zombies just as they do to Ghouls,Gremlins,Werewolves,Night Stalkers,Vampires and other members of the Undead Community.

[cahmd]

We peasants should not forget Dr. Barney Frankenstein when we finally get around to burning the Capitol.

[Pagar]

"what other lending opportunities?"

With mortgages having been rendered totally useless and the government having assumed control over every thing in our lives. I can't imagine putting money into any so called opportunity.

[StrawmanCometh]

Caught some of the CNBC "House of Cards" special on the sub-prime meltdown. 3 couples were featured as the face of the crisis sob stories. These people had refinanced to redecorate, fix up the back yard and pay off credit cards. Oddly though, the actual $amounts of any of these transactions were never mentioned. Do you think this information might have spoiled the sympathy narrative? One of the couples was Mexican with limited English, they were not asked if they were in the country legally.

[mel]

If courts decide that the terms in a mortgage contract are written in pencil, there will never be a recovery in the housing market because there will be no capitalization of the mortgage market ever again.

[Old Lurker]

jimmyk, it gets even worse.

WSJ reports Saturday that the proposal coming as soon as next week will empower BK judges to write down loan amounts to FMV, reduce interest rates, extend amortization periods, and make it very costly and time consuming to pursue foreclosure. In addition, lenders holding/servicing existing mortgages will be protected from lawsuits from bondholders secured by those mortgages who want the lenders to enforce the rights they thought they had when the bonds were sold.

So not only are the progs destroying the future mortgage market, they are, as they do, rewriting the deals that underpinned decades of commerce, supported by the knowledge that rights were understood and constitutionally protected. That reliable rule of law is why global capital flows here as opposed to some banana republic.

Or used to.

Bad is correct "Happy VD" all.

[Pofarmer]

write down loan amounts to FMV

so, will the bank eat the write down, or will it come out of the TARP kitty?

[Old Lurker]

The bank will eat the writedown, of course, except to the extent they can pass the buck (gee there's a bad pun) to the bondholders who bought that basket of loans.

Like Thatcher said "Socialism works until they run out of other people's money".

[Pofarmer]

So, you've got BK judges mandating writedowns, in a falling housing market, and the lending institutions have to eat them.

I thought we DIDN'T want to bankrupt the lending institutions? I should probably nail down everything on my desk. This is going to be a long spell in here.

[Rick Ballard]

An examination of similarities between the inbred and moribund status of the leadership of the keiretsu in Japan and the bands of credentialed moron lemmings composing the leadership of American finance might be more productive. Japan's zombies were bred and indoctrinated within a system which rewarded high achievement at the high school level with admittance to "elite institutions" where they made the contacts so necessary for advancement within the keiretsu.

Sound familiar to anyone?

The US will not replay Japan Inc. from 1990 forward. Japan Inc. was dealing with increasing demographic stagnation which saw Japan's population grow by a cumulative total of 4.16 million (3.3%) over the period of 1990-2007. The US grew by a cumulative 52.6 million (21.1%) in the same period. Japan Inc. has survived only because of successful exploitation of the strong demographic growth of the US, the same thing which propels China's growth.

The blithering idiots comprising our credentialed moronic elite have advanced the concept of 'decoupling', equating increasing low margin sales growth within Asia with high margin sales growth to the US. We are in the process of seeing that absurdity exposed at the same time that we are seeing the exposure of the wondrous inflexibility involved in unwinding the mess created by inattention to the devolution in adherence to the precept that "a man's word is his bond" with regard to repayment of incurred debts.

There are definite similarities between the credentialed morons of Japan's keiretsu and the sclerotic cretins doing the backscratching at the top here but the outcome will not be the same. I'm not suggesting that it will be better, just that it will not be the same. Demographics and population density dictate an alternative outcome.

[Caro]

Happy VD, all.

You can listen to Larry Kudlow on Saturday mornings here.

[Old Lurker]

RB: "...Demographics and population density dictate..."

Hence the demise of Europe, the UK and Russia.

Toast.

[Rick Ballard]

OL,

Yep. Just as the Asian "old friend" networks patterned on Japan's keiretsu model dictate sclerosis in true innovation due to the squelching of competition through inhibition of lending to "new" enterprise. That, at least, was covered in the Ahearne/Shinada paper, albeit, without exploration of the "backscratching" within keiretsu.

I keep looking at the "strength" of the euro and yen and wondering exactly what kind of drugs are passed between forex traders. Germany's economy is as heavily export dependent as Japan's and Germany is the engine driving the EU.

Interesting times.

[MayBee]

I'm going to wade in here, where I don't really know what I'm talking about, but I'll give it a go. I don't mind being wrong.

But.
A friend that worked for a Japanese bank told me their culture played an important role in another way. The banks had guaranteed their employees mortgages, and Japan had/has a strong culture of jobs for life.
The banks couldn't get rid of their employees, and they couldn't dump those mortgages.

That said, we rented our home in Tokyo from the former chairman of one of the banks. It was one of several he owned, it was massively cool, and it was nothing compared to his own compound, which was around the corner. So he did ok through the whole debacle.

[Old Lurker]

Indeed. I'm sure you saw/read Jim Rogers last week declaring, basically, that there is no there, there with the Euro and he expects it to not survive another decade or so.

[Pofarmer]

One other thing the Japanese did, was they would actually sign multi-generational morgages. Things haven't quite gotten quite that much out of kelter----yet.

[Old Lurker]

MayBee, EVERY system of social organization results in winners and losers. Those Soviets with their limos, dachas, and swiss accounts lived very, very well. The coming new age of America will too.

If you read closely last week, you will recall Rick mapping who gets to live on the windward side of the island, and who in the lee.

[Rick Ballard]

OL,

Sell the cool breezes, don't mention "brunt of hurricane's force". Location, location, location.

MayBee,

"So he did ok through the whole debacle." It's hard to find a keiretsu member who has actually individually paid for his errors. They've shifted the burden to society in general in a manner that is the envy of our credentialed Wall Street morons. Some of the Wall Street boys have actually had to pay for their collective stupidity.

NOTE: I realize that there are scads of smart, hard working, ethical people working on Wall Street. It's just a shame that they can do nothing about the vermin which have overrun its institutions.

[daddy]

Rick,

From where I sit all the old thumb-rules for the value of the US Dollar in foreign currencies are out the window. Used to be it was reliably a dollar to 115 Yen as a ballpark for years at a time, or 1.4 US to a Euro, or a buck equals 8 Chinese RMB's, etc. Now its huge fluxes in Euro or Yen rates every time I drop in for a layover. Since its almost impossible for the drop-in traveller in Japan to find a cash machine that dispenses anything less than 10,000 Yen at a shot, (Ballpark 90 bucks) now I have to get 20,000 every stopover, because nobody knows what to expect since we last arrived, and you really don't have a choice because they charge such a horrendous extra percentage penalty charge for using a credit card that you always need to avoid that. And FWIW, my favorite Expat Pubs in Japan say business is awful and that they are dying on the vine. Two weeks back we won 5000 Yen worth of Free Beer tix in the Sunday Night Trivia Contest at the Barge Inn in Narita. This is almost impossible to imagine because the community of Canadian English teachers always kick everybodies rear end. The manager said times are so bad locally that the teachers have all gone home because locals no longer have the extra cash or incentive to pay for English lessons, so when me and my crew are winning intelligence competitions in Asian Bars you can take it as Gospel that times are rough all over.

[bad]

Rick, are you saying the Octomom has done us a favor in birthing all those babies?

[glasater]

Some words of wisdom from an old hand--Henry Kaufman.

Final graphs:

A central goal of new financial legislation should be to rein in extreme financial behavior. To inject some restraint into the rampant securitization that contributed so much to the current crisis, loan originators should be made responsible for a portion of repackaged loans. Off balance sheet activities should be brought back onto the balance sheet. Credit derivatives should be limited to a small proportion above the outstanding credit obligations. Financial conglomerates, which by their sprawling scale and scope are vulnerable to conflicts of interests, should be given special scrutiny by regulators.

These and similar measures will help induce financial institutions to balance their entrepreneurial drive with their fiduciary responsibilities. And if that happens, the next secular swing in interest rates should be more moderate than the great interest wave we have just ridden.

[RichatUF]

Excellent comments Rick, didn't even think to look at the comparison using the keiretsu.