Is the world learning to say ‘no’ to debts?

Following the demise of Lehman Brothers, Merrill Lynch and the giant insurer AIG, we are learning to fear debt—like Japan in the 1990s, says an article in Prospect.

The facts of the Japanese debacle are broadly these: the Nikkei index of leading shares peaked at 38,916 on 29th December 1989 at the end of a five-year long orgy of debt-fuelled speculation, centred largely on the real estate market. During the fat years, banks lent against property in the confident expectation that prices would never fall. For a while, they were amply rewarded: share and real estate values rose fourfold between 1984 and 1989. It took time for the crisis to bite hard, but from 1990 share prices started a 13-year decline, punctuated by sharp rallies. Over that period they gave up all their bull market gains, and by 2002, the stock market was back where it had been in 1984. Property values also crashed. In total, the long decline wiped out ¥1,500 trillion ($14.2 trillion) of national wealth, equivalent to three years of Japanese GDP. It was the largest such loss experienced by a nation in peacetime.

The demon the Japanese confronted during the lost decade was that of “de-leveraging.” This arose initially because banks were reluctant to lend, and then because too many borrowers paid down debt at the same time—a toxic combination that crushed asset prices (they had to sell off property to pay their debts). It is this fear that is now stalking financial markets. A rerun of what happened in Japan is possible, although with luck not in as savage a form.

Rather as in late-1980s Japan, banks today have lent too much money to bad borrowers. Having made big losses, they are concerned about more bad debts coming down the line, eroding their capital. This has made them extremely reluctant to lend—even to one another. The supply of credit to personal and corporate borrowers has all but dried up. Moreover, fear about vast losses—still hidden in the system—has communicated itself to investors, who are openly questioning the value of the collateral banks are holding against the loans they have made. Such doubts were behind the collapses of Lehman and Bear Stearns, as well as Britain’s biggest casualty, Northern Rock.