The Lesson of Yamaichi

The tragedy of Lehman Brothers and the following jump of interbank rates remind me of a similar event in Japan eleven years ago. Yamaichi Shoken, one of the Big Four security brokers, filed to close business in November, 1997.

It was a consequence of an accident brought about by the bankruptcy of another broker, Sanyo Shoken. When Sanyo failed in early November, an interbank loan to it was defaulted. It made all banks panic so that Hokkaido Takushoku Bank and Yamaichi failed because they couldn't get the interbank loan.

The Ministry of Finance let Yamaichi fail because it was only a broker. However, Fuji Bank, the "main bank" of Yamaichi became the target of short selling, because Yamaichi's bankruptcy signaled the liquidity crisis of Fuji. Then overall credit crunch emerged, which forced the MoF to bailout 21 major banks in 1998. It was similar to that of AIG.

But the bailout didn't end the problem. In the end, Japan Long Term Credit Bank and Nippon Credit Bank were nationalized in 2000. Japanese government established RCC (Resolution and Collection Corporation) to buy the bad loans by public money. However, the crisis didn't end until 2002, Heizo Takenaka, the Minister of Economy and Finance, threatened major banks to write off the bad loans quickly.

The lesson is that market mechanisms don't work for dying companies. They never die voluntarily but insist that they are "not insolvent but only illiquid". So if the central bank supply plenty of money, they struggle to survive by pumping up public money. Since it takes a long time until the bank's money dries up, government intervention is inevitable.

On September 19, the U.S. Treasury Department and FRB proposed a plan to set up a public institution to resolve the bad loan, like the RTC for the S&L scandal. Many economists agreed their proposal, but Luigi Zingales made an objection. Indeed his criticism for the "socialization" of private loans is economically rational, but rational policies don't work for irrational banks. Probably we need libertarian paternalism.