The U.S. Financial Crisis: Lessons From Japan

The U.S. Financial Crisis:
Lessons from Japan
Dick K. Nanto
Specialist in Industry and Trade
Foreign Affairs, Defense, and Trade Division
Summary
Japan’s five bank bailout packages in the late 1990s may hold some lessons for the
United States. Most of the packages were administered by the Deposit Insurance
Corporation of Japan (DICJ). The packages had an announced value of $495 billion.
The DICJ reports that it provided $399 billion to Japan’s troubled financial institutions
of which it has recovered $195 billion. Overcoming the crisis in Japan’s banks took a
combination of capital injections, new laws and regulations, stronger oversight, a
reorganization of the banking sector, moderate economic recovery, and several years of
banks working off their non-performing loans. This report will be updated as
circumstances warrant.
When the U.S. Treasury planned the $700 billion bailout package (Emergency
Economic Stabilization Act of 2008, H.R. 3997/H.R. 1424) to address the U.S. financial
crisis, it reportedly examined the experience of Japan as it grappled with its banking crisis
in the 1990s.¹ This report reviews the major actions by the Japanese government in
dealing with its crisis and highlights some of the lessons learned from their experience.
Like the current U.S. financial crisis, Japan’s began with stock market and real estate
bubbles. During the latter half of the 1980s, Japan’s monetary authorities flooded the
market with liquidity (money) in order to enable businesses to cope with the rising value
of the yen. Businesses did invest in new capital equipment to become more competitive
in international markets, but the excess liquidity also found its way into speculation in
Japan’s stock market, in real estate ventures, and in foreign investments. At that time, the
market value of both land and equities was rising so fast that investors and speculators
could hardly miss. Investors tended to ignore risks. The larger mistake for them was not
to borrow and invest and consequently not be positioned to reap the returns from rising

¹ Faiola, Anthony and David Cho. “Alternative Solutions Diverge From Administration’s
Approach,” The Washington Post, September 24, 2008. p. A.1.

markets. Banks considered most loans with real estate as collateral as being
unquestionably secure. Then the bubbles burst.
Japan’s Nikkei stock market average peaked in 1989 at 40,000 and dropped by 50%
in one year and more than two-thirds to about 12,000 by August 2001. Japan’s banks are
allowed to hold equities as part of their capital base. The value of the unrealized capital
gains on such stock holdings dropped from $355 billion in 1989 to $42 billion in 2001.
This drastically reduced key capital reserves for many banks. Also, by 2000, commercial
land values in the six major metropolitan areas had fallen by 80% from their peak level
in 1991. Residential and industrial land values also had fallen by nearly 20%.²
The bursting of this economic bubble caused the value of collateral underlying many
bank loans to drop below the value of their loan principal. Also, commercial real estate
ventures, especially office buildings, became unprofitable as rents fell. As the economy
slowed, companies also faced excess capacity, excess inventories, and lower profits. Also
as more and more loans turned sour, more and more of the underlying real estate had to
be sold at “bargain” prices. In 1995, Japan’s banks reported $280 billion in non-
performing loans,³ but this figure turned out to be vastly understated.⁴ Japanese financial
institutions at this time, however, generally did bundle and repackage these loans as
collateralized debt obligations or rely extensively on derivatives or other financial
instruments. Mortgage defaults tended to be on commercial property, not on private
residences.
At first, the Japanese government’s strategy was forbearance, a strengthening of
deposit protection, provision of emergency liquidity, and some assistance to encourage
mergers of failed institutions. The crisis worsened in 1995-1996 following the
bankruptcy of several specialized housing loan companies (jusen). In 1996, the
government made its first injection of capital to purchase assets from ailing housing
lenders. This bailout proved to be quite unpopular politically and may have contributed
to tentativeness later on the part of government as the downward spiral quickened.
By 1997, Japan’s banking sector was in a full systemic crisis. The government
responded by making $250 billion (¥30 trillion) available of which $108 billion (¥13
trillion) went to banks and $142 billion (¥17 trillion) to the Deposit Insurance Corporation
of Japan. In 1998, the government bought the bankrupt Long-Term Credit Bank⁵ and
Nippon Credit Bank. These two banks had no consumer deposit system but borrowed
funds on financial markets to lend on a long-term basis to businesses. These banks were
eventually sold to private investors. The government also took over the management of
many financial institutions.
In March 1998, the government injected another $14 billion (¥1.8 trillion) to bolster
bank balance sheets and in March 1999 injected another $62.5 billion (¥7.5 trillion). By

² Bank of Japan. Financial and Economic Statistics Monthly, various issues.
³ Japan. Financial Services Agency.
⁴ For details, see CRS Report RS20994, Japan’s Banking “Crisis,” by Dick K. Nanto.
⁵ Later bought by the New York-based Ripplewood Holdings and other investors.

October 1998, the government had invested $495 billion (¥60 trillion yen), or 12% of
gross domestic product, for the financial support of banks.⁶
For much of the 1990s, however, the hope of the government was that if it could
keep banks operating, their profits from operations and capital gains from equity holdings
could fund the writeoffs of bad loans. The Bank of Japan kept its interest rate for banks
low so that they could increase profits from new lending. Between 1995 and 2003,
Japan’s banks wrote off a cumulative total of $318 billion (¥37.2 trillion) in non-
performing loans, but new ones appeared so fast that the total outstanding amount kept
increasing and peaked in March 2002 at $330 billion (¥43.2 trillion) or 8.4% of total
lending.⁷
Through a combination of capital injections, new laws and regulations, stronger
oversight, a reorganization of the banking sector,⁸ moderate economic recovery, and
several years of banks working off their non-performing loans, the Japanese banking
sector now has recovered. By September 2005, the banks reported 3.5% of their total
lending as non-performing, a tolerable amount. By 2008, Japanese banks and brokerage
houses had become strong enough that Nomura Holdings had agreed to buy the Europe
and Middle East operations of Lehman Brothers as well as Lehman’s franchise in Japan
and Australia. Mitsubishi UFJ Financial Group has agreed to buy 20% of Morgan
Stanley.⁹
Net Cost of Bailouts
The various bailout packages in Japan were administered primarily by the Deposit
Insurance Corporation of Japan (DICJ). When a financial institution fails, the DICJ may
extend assistance to another financial institution that purchases assets or merges with the
failed financial institution in order to facilitate the transaction. The DICJ also works to
prevent financial institutions from failing. The forms of assistance include a direct money
grant, a loan or deposit of funds, purchase of assets, a guarantee or assumption of debts,
a subscription of preferred stock, and loss sharing. Not all of the activities of the DICJ,
however, are related to the bailout packages. It also has ongoing operations associated
with its traditional function of insuring bank deposits. The annual reports of the DICJ,
however, provide detail on the disposition of $399 billion of the $495 billion in funds
announced in Japan’s financial assistance packages.

⁶ For the United States, 12% of GDP in 2008 dollars is about $1.7 trillion.
⁷ Japan. Financial Services Agency. Quoted in Organization for Economic Cooperation and
Development, OECD Economic Surveys, Japan (Paris, OECD Publishing) Vol. 2006/13, July

2006, p. 53.

⁸ The Industrial Bank of Japan, Daiichi Kangyo, Fuji, and Yasuda Trust Banks merged to form
the Mizuho Financial Group (2003). The Bank of Tokyo-Mitsubishi, Mitsubishi Trust Bank, and
Nippon Trust Bank merged to form the Mitsubishi Tokyo Financial Group (2001). Sumitomo
Bank and Sakura Bank merged to form the Sumitomo Mitsui Financial Group (2002). Sanwa
Bank, Tokai Bank, and Toyo Trust & Banking merged to form UFJ Holdings (2001). Asahi Bank
merged with Daiwa Bank to form Resona Holdings (2001).
⁹ “Bailout Faces Delays as Goldman Gets Boost.” Reuters, September 23, 2008.

As shown in Table 1, as of March 2007, the DICJ had provided financial assistance
in the amount of $399 billion. This included 180 cases with grants of $159 billion, asset
purchases of $83 billion, capital injections of $106 billion, and other assistance (mostly
loans) of $51 billion.
The grants were funded by $110 billion (¥13 trillion) in DICJ bonds issued (repaid
from taxpayer funds) and from premiums from deposit insurance. Of the asset purchases
of $83 billion, the DICJ recovered $79 billion. The asset purchases included $54 billion
in assets from failed financial institutions (of which $60 billion had been recovered) and
$25 billion in shares purchased (of which $14 billion had been recovered).
Table 1. The Deposit Insurance Corporation of Japan’s Assistance
to Financial Institutions and Funds Recovered as of March 2007
Type Am ountP r ovided Am ountRecovered
1. Grants$159 billionNone
(¥18.6 trillion)
2. Purchase of Assets $83 billion$79 billion
(¥9.8 trillion)(¥9.3 trillion)
Of which:
$54 billion$60 billion
(¥6.3 trillion)(¥7.0 trillion)Purchase of assets from failed institutions
Purchase of shares from banks under public$25 billion$14 billion
management(¥2.9 trillion)(¥1.6 trillion)
3. Capital Injections Under Five Bailout $106 billion$75 billion
Packages(¥12.4 trillion)(¥8.7 trillion)
4. Other $51 billion$41 billion
(¥6.0 trillion)(¥4.8 trillion)
Of which:
$36 billion$36 billion
(¥4.2 trillion)(¥4.2 trillion)Loans
Total$399 billion$195 billion
^Source:^D^e^posⁱ^t^In^s^u^ran^{ce C}^o^rporatⁱ^oⁿ^of^Japan^,^Annual^Repor^t²⁰⁰⁶^{, p. 70.}
^No^te:^A^l^l^v^a^l^u^es^con^v^e^rt^{ed at}^t^h^{e March}^{2007 ex}^ch^an^g^e^rat^e^of^{116,26 y}^eⁿ^{per dol}^l^a^r.
^C^a^pi^t^a^lⁱⁿ^j^ectⁱ^oⁿ^sⁱⁿ^cl^u^d^{ed pu}^rch^a^s^e^s^of^pref^erred/^com^m^oⁿ^s^t^ock^an^{d s}^u^bordiⁿ^a^t^e^d^bon^ds^an^d^t^h^{e ex}^t^eⁿ^dⁱⁿ^g
^of^s^u^bordiⁿ^a^t^e^{d l}^o^an^s^.
Capital injections of $106 billion came under five different bailout packages and
included subscriptions to preferred or common stock, purchases of subordinated bonds,
and the extending of subordinated loans. The DICJ had injected capital into 25 different
banks. As of March 2007, $31.3 billion of these assets was still held by the DICJ in the
form of preferred shares, common shares, and subordinated loans.

The $51 billion in the “Other” category included loans to banks which were under
special public management, taking delivery of assets under warranty for latent defects,
compensation for losses, lending to assuming financial institutions, and debt assumption.
The last capital injection reported by the DICJ was in March 2003.¹⁰
The Resolution and Collection Corporation (RCC), a subsidiary of the DICJ,
borrows funds from the DICJ to purchase and dispose of assets (within three years) from
sound financial institutions and some under special public management. As of March
2007, the RCC had purchased assets with claims of $34.5 billion (¥4.0 trillion) for a
discounted price of $3.0 billion (¥355.7 billion). These assets had been sold for $5.2
billion (¥609.4 billion) for a gain of 172% for the RCC. In essence, the RCC paid about
9 cents on a dollar for the troubled assets and was able to dispose of them at a profit. The
DICJ consults with the Purchase Price Examination Board (an advisory body to the DICJ)
with respect to the price it pays for assets. The RCC made no purchases in FY2006
(ending in March 2007).¹¹
Lessons Learned
The following are various lessons and observations that observers have gleaned from
the Japanese experience.
^!Authorities underestimated the nature and seriousness of the banking
problem at first. Most thought the financial problems would resolve
themselves through economic growth and by keeping central bank
interest rates low in order to increase bank margins and profitability.
^!There was a slow recognition of the extent of non-performing loans and
the carrying of “zombie” firms that technically were bankrupt but were
kept alive by banks. This delayed resolution of the problem.
^!Transparency and an updating of definitions and reporting requirements
with respect to non-performing loans was important in realizing the true
extent of the problems. Many of the rescues of ailing financial firms by
a healthier financial institution required a government injection of capital
in some form.
^!There appeared to be a lack of domestic or external constraints and of
political leadership that would have urged authorities to take more
decisive action earlier.¹²
^!The government began by creating new institutions to handle emergency
financial assistance but later transferred such activities to the Deposit
Insurance Corporation of Japan (DICJ), an institution that already was

¹⁰ Deposit Insurance Corporation of Japan. Annual Report 2006, p. 19, 91. Note: 65% of the
outstanding balance of shares was in the Resona Bank. In 2006, the DICJ received $132 million
in dividends from these Resona Bank shares but paid $57 million in interest on its bonds floated
to finance the purchase of the shares.
¹¹ Ibid., p. 22, 70, 84.
¹² Kawai, Masahiro. “Reform of the Japanese Banking System.” International Economics and
Economic Policy. Heidelberg: Dec 2005. Vol. 2, Issue 4; p. 307ff.

working with troubled financial institutions. The DICJ also was given
permanent authority to assist ailing financial institutions when so ordered
by the Prime Minister.
^!The Japanese government injected capital into financial institutions in
several ways depending on the situation. In most cases, the DICJ could
use its discretion in determining the nature of the assistance.
^!Troubled assets were bought at a steep discount from their face value
from sound financial institutions (to inject capital) and disposed of
without unduly disturbing markets — usually within three years. The
two banks that were nationalized were later sold to private investors.
Capital injections also took the form of subscriptions to stock, grants, and
subordinated loans.
^!Even with the $495 billion financial bailout packages, between 1998 and
2003, Japan’s banks wrote off some $318 billion in non-performing
loans. The burden was shared.
^!Government holdings of corporate shares have generated dividend
income and capital gains for the DICJ.
^!Since there are fewer banks in Japan, the authorities could focus recovery
efforts on several large banks and fewer than 200 smaller financial
institutions (there are about 8,500 banks in the United States) which
facilitated information gathering and coordination.
^!When Japan announced an early financial bailout package, it placed
stringent conditions on the assistance that banks were unwilling to
accept. The net result was that the banks ignored the package and tried
to bolster their balance sheets by not lending. This was seen as
worsening the economic conditions for the country.¹³ Most of the
assistance to failing institutions, however, carried conditions that were
enforced by the DICJ.
^!New technologies, globalization, and the blurring of boundaries between
types of financial products and institutions made risk management
increasingly difficult for financial regulators.¹⁴
^! The bursting of the real estate bubble in Japan caused more difficulty for
banks than the bursting of the bubble in stocks because the decline in real
estate values affected the value of collateral on much bank lending.¹⁵
^!Japan is considered to have acted too slowly with respect to monetary
policy, fiscal policy, and the resolution of problems in the banking sector.
Once the economy began to recover, fiscal policy is thought to have
tightened too soon.¹⁶

¹³ Slater, Dan. “Economist Draws Parallels Between U.S., Japan Banking Crises, Business Week,
March 31, 2008. Internet edition.
¹⁴ Nagano, Satoshi. “Lessons Learnt from the mounting Non-performing Loans in Japan after the

1990s,” Journal of Financial Services Marketing, Vol. 11, 2, pp. 180-89.

¹⁵ Browne, Lynn Elaine. “Does Japan Offer Any Lessons for the United States?” New England
Economic Review, 2001, 3, p. 3.
¹⁶ Ibid.