Will Bank Recapitalization Succeed?

This post comes from Anil K. Kashyap of The University of Chicago.

I recently presented a new working paper co-written with Takeo Hoshi at the Law, Economics and Organizations workshop at Harvard Law School entitled Will the U.S. Bank Recapitalization Succeed? Lessons from Japan. In the paper, we look back at Japan’s decade-long response to its financial crisis and evaluate what has and hasn’t worked, and draw on the Japanese experience to evaluate the Troubled Assets Relief Program (TARP), which focused on the idea of purchasing troubled assets to stabilize the financial system, and the Capital Purchase Program (CPP), which focuses on acquiring stakes in banks in the form of preferred shares and warrants.

While it is widely known that the banking problems in both countries began after a sharp increase in land prices, the events in Japan from late 1997 to early 1999 closely track developments in the U.S. in 2008. One important similarity is the bank credit crunch that prevailed in both instances. More importantly, the Japanese banks emerged from the acute phase of its crisis with seriously undercapitalized banks. We identify four main problems with the string of Japanese asset purchase plans and capital injection programs that were pursued to combat the banking problems. First, the asset purchase plans were too narrow. The scope of assets to be purchased and the set of financial institutions included were limited, thus precluding a comprehensive plan. Second, the loan purchases that did take place, especially in the 1990s, involved little restructuring of the borrowers. This resulted in many of the companies operating with few changes while typically receiving more loans that subsequently went bad. Third, the capital purchase plans ran into trouble in getting the banks to accept funding. Fourth and most importantly, the overall amount of government money committed was too small to recapitalize the banks. Hence, the banks only really returned to being adequately capitalized in 2006 and 2007, when macroeconomic conditions improved and after supervision policy had changed.

In broad terms, the TARP and CPP programs mimic many elements of the Japanese plans. We present data comparing the largest U.S. banks, particularly in terms of the risks that they face from continued deterioration in the economy. Based on publicly available data it is hard to make confident assessments about the solvency of the banks. The lesson from Japan is that the details of the potential recapitalization program will be critical in determining whether any injections will increase the banks’ capital levels and hence their lending capacity. While the U.S. plans are still in flux, it appears that U.S. is at risk for running into some of the same problems that hobbled the Japanese policies.

The full paper is available for download here.

Other posts about: , , , ,
Other posts from:
Post a comment or leave a trackback: Trackback URL.

One Comment

  1. Posted Thursday, March 12, 2009 at 8:08 pm | Permalink

    himm interesting !!

Post a Comment

Your email is never published nor shared. Required fields are marked *

*
*

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>

  • Subscribe

  • Cosponsored By:

  • Supported By:

  • Programs Faculty & Senior Fellows

    Lucian Bebchuk
    Alon Brav
    Robert Charles Clark
    John Coates
    Alma Cohen
    Stephen M. Davis
    Allen Ferrell
    Jesse Fried
    Oliver Hart
    Ben W. Heineman, Jr.
    Scott Hirst
    Howell Jackson
    Wei Jiang
    Reinier Kraakman
    Robert Pozen
    Mark Ramseyer
    Mark Roe
    Robert Sitkoff
    Holger Spamann
    Guhan Subramanian

  • Program on Corporate Governance Advisory Board

    William Ackman
    Peter Atkins
    Joseph Bachelder
    John Bader
    Allison Bennington
    Richard Breeden
    Daniel Burch
    Richard Climan
    Jesse Cohn
    Isaac Corré
    Scott Davis
    John Finley
    Daniel Fischel
    Stephen Fraidin
    Byron Georgiou
    Larry Hamdan
    Carl Icahn
    David Millstone
    Theodore Mirvis
    James Morphy
    Toby Myerson
    Barry Rosenstein
    Paul Rowe
    Rodman Ward