Friday, February 27, 2009

Zombie everything

I think this post from the boys at The Economist goes in the right direction.  They correctly point out that it might be difficult to fix the economy if you are not even sure what the problem is.  For example ...

Maybe it's the Zombie banks:

In one corner, we have Paul Krugman and Adam Posen. Mr Krugman cites Mr Posen in a blog post today, saying:

The guarantees that the US government has already extended to the banks in the last year, and the insufficient (though large) capital injections without government control or adequate conditionality also already given under TARP, closely mimic those given by the Japanese government in the mid-1990s to keep their major banks open without having to recognize specific failures and losses. The result then, and the emerging result now, is that the banks' top management simply burns through that cash, socializing the losses for the taxpayer, grabbing any rare gains for management payouts or shareholder dividends, and ending up still undercapitalized. Pretending that distressed assets are worth more than they actually are today for regulatory purposes persuades no one besides the regulators, and just gives the banks more taxpayer money to spend down, and more time to impose a credit crunch.

These, in Mr Krugman's words, are, "[Z]ombie banks, unable to supply the credit the economy needs". The problem is that the economy will stagnate without a functioning banking system. Government transfers to the financial system, to date, are far too small to make the banks whole, and transfers of sufficient size would represent an enormous giveaway to shareholders. The solution, in this case, is nationalisation.

But the again, maybe it's the Zombie borrowers:

In a second corner we have Richard Caballero, Anil Kashyap, and Takeo Hoshi, who argue that the big problem with Japanese banks was not that they could not provide adequate credit to the economy, but that they continued to supply credit to the economy when they shouldn't have. In a paper titled, "Zombie lending and depressed restructuring in Japan", they write:

This paper explores the role that misdirected bank lending played in prolonging the Japanese macroeconomic stagnation that began in the early 1990s. The investigation focuses on the widespread practice of Japanese banks of continuing to lend to otherwise insolvent firms. We document the prevalence of this forbearance lending and show its distorting effects on healthy firms that were competing with the impaired firms...

Aside from a couple of crisis periods when regulators were forced to recognize a few insolvencies and temporarily nationalize the offending banks, the banks were surprisingly unconstrained by the regulators.

The problem is that zombie banks kept credit flowing to "zombie borrowers". Without good investment opportunities available (given economic conditions) these loans merely propped up failing firms.

Or, finally, it might be the Zombie consumers:

And in a third corner, we have Martin Wolf and Richard Koo. They argue that the root of the Japanese lost decade wasn't the banks at all—it was household debt. Mr Wolf writes:

Most of the decline in Japanese private spending and borrowing in the 1990s was, argues Mr Koo, due not to the state of the banks, but to that of their borrowers. This was a situation in which, in the words of John Maynard Keynes, low interest rates – and Japan's were, for years, as low as could be – were "pushing on a string". Debtors kept paying down their loans.

The problem is that households will neuter monetary policy by working to pay down their unmanageable debts. Banks are not an issue at all, so long as they aren't threatening the financial system by failing. The solution here is too prevent systemic collapse as cheaply as possible. In all likelihood, this involves propping up bad banks until they can earn their way out of insolvency, and engaging in large scale fiscal policy to avoid a debt-deflation spiral.

Fortunately, in the current situation, this turns out to be a remarkably easy question to answer; we've got Zombie everything.  Banks that don't want to lend, private equity companies that borrowed a lot and are now the only ones with an appetite for more borrowing (which unfortunately just goes to prop them up), and consumers that just want to pay off their debt. 

Zombies of the world unite!  You have nothing to lose but your brains!

1 comment:

adamcc said...

Yeah, isn't that why we need huge stimulus to make up for the zombie demand AND seizure & reprivatization to re-animate the zombie banks? Zombie businesses I'm less sure about, but one could start with cutting agri subsidies.