The Banking Crises in Japan and the U.S. Are More Similar Than You Think
The lending boom appears to be over.
A month go, we talked about how the Senior Loan Officer Opinion Survey (“SLOOS”) has shown banks are tightening lending standards.
It was already getting tougher to get a loan, and that trend has accelerated because of the chaos that has happened over the last few months in regional banks.
Banks are asking for more income verification on their loans, only supporting higher quality borrowers, raising interest rates, and doing many other things to slow down lending, including just saying “no.”
Now it looks like the Fed is starting to wake up. They’re realizing this issue is getting worse.
Some Fed leaders have voiced concerns about what this means for lending and the U.S. economy.
President and CEO of the Chicago branch Austan Goolsbee said what we’re seeing now is just the beginning.
We think the Fed is right. Only we don’t think it’s going to lead to some calamitous collapse in the economy or markets.
We think there’s another way the problems regional banks have gotten into from gorging on low interest loan underwriting may play out.
And to explain this, we’re going to give a history lesson.
Today, we’re going to tell you about Japan and why some parts of the U.S. banking system might be set up to recreate Japan’s mess if we’re not careful.
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Japan was supposed to be the next superpower.
In the late 1980s, Japan looked like it was on top of the world. It was on its way to pass the U.S. in GDP, and everyone was in awe.
And then something happened, it’s not some mystery.
Japan had fueled much of that mania on cheap debt from Japanese banks.
Companies had borrowed tons of money to grow and invest, and then when the economy slowed down, and those companies couldn’t pay back their debt.
Japanese banks didn’t want to force these companies into bankruptcy, because then they’d have to realize they had made these losses.
Also, many of these banks are part of massive conglomerates known as keiretsus that had lent to their sibling firms in the conglomerate, so it didn’t benefit them to let them go under.
The banks were also worried about the effect of bankruptcy on employment and the economy as a whole.
So, the banks just started to refinance these loans to companies at the same low rates.
Instead of letting these companies go under, taking the loan losses, and cleaning up their balance sheets to make new loans in the economy, they just papered over the issues.
It stifled growth and created zombie companies… and turned the banks into zombie banks that weren’t doing their job of extending credit.
And Japan’s market still hasn’t recovered. The Nikkei 225 Index, the major index composing of companies in the Tokyo Stock Exchange (“TSE”), reached an all-time high in 1989 and hasn’t recovered in over 30 years.
Take a look…
Banks that were making bad decisions and keeping companies that should’ve gone bankrupt alive made the infamous Japanese economic crisis as bad as it was.
History might be repeating itself in a different part of the world.
Right now we’re at risk of many regional banks in the U.S. doing the exact same thing. For many of these banks, it makes more sense to extend loans and help companies refinance loans than to push for a real refinancing at higher rates that could lead to defaults.
If they did play hardball, the ensuing defaults could blow up banks, capital levels, and sink the banks. Many companies can’t afford the loans they’ve taken out at current higher rates.
That would likely be the first step to a Japanification of the U.S. financial system.
Fortunately, the situation in the U.S. isn’t entirely set up like Japan.
In Japan, the banks were shielded from the market by the conglomerates and the government.
In the U.S., we’ll see that the market can force the issue for banks it is really worried about. It can make them have to confront their issues.
We’ve seen the market try to do this with some banks recently, including some of our own recommendations that we’ve had to recommend readers close out of, as the market turned against them.
While the market can overreact for one or two banks, overall it’s healthy that the market is pushing banks to do what they should.
Since these banks are having to confront their issues, they’re more likely to clean up their dirty laundry, or have capital sent to other banks who will run things better.
That being said, there are still over 4,000 banks in the U.S. While the market is taking many of the medium-sized regional banks to task, there are plenty of the tiniest banks, either public or private, that are flying under the radar.
These banks don’t have loans that are about to default. They have borrowers who are locked in at artificially low rates that mean the banks can’t loan more. They also have borrowers who can afford their loans now, but can’t afford them at higher rates.
And since they aren’t under the market’s microscope right now, they’re the exact kind of banks that could become like those Japanese banks. And that would mean that the U.S. economy’s structural growth rate could be lower than it would be otherwise.
And that’ll be true until interest rates come down so these banks can have a sustainable balance sheet. We could be headed for a short-term lending winter.
We could see the Japanification of chunks in our financial system and that means continued weak growth as we head into a recession, and even when we come out of it.
That just further reinforces that even as the market is sitting close to its highs for 2023, and some are looking optimistically at the market, you are going to have to be smart and focused when investing in the coming months if you’re going to make money in the market.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research