Looking at Japan to learn how to cope with a crash

Can Ireland, asks David McNeill, learn anything from Japan's 1990s imploding property bubble and stock market crash?

PLUNGING PROPERTY prices, mounting bad loans, spooked investors and the panicky sound of banks splashing around in red ink. At first glance, the parallels between Ireland today and Japan's painful 1990s slump are striking.

Initially sparked by an imploding property bubble, Japan's problems eventually engulfed every sector of the economy, dragging down several large banks, humbling many of its once world-beating corporations and miring the country in a decade of deflation and stagnation. Known here as "the lost decade", the 1990s has gone down elsewhere as one of history's worst economic reversals. Is Ireland in for similar pain?

The early warning signs here have been noted. Ireland's economic growth is set to slow in 2008 to its weakest pace since 1992, says the Economic and Social Research Institute. The stock market has lost more than 37 per cent of its value since June last year, according to MSCI Ireland, considerably worse than Japan's performance in the early 1990s. The larger banks have seen up to 40 per cent of their market value wiped out.

Most striking of all in a country where property accounts for about 15 per cent of the economy and more than 60 per cent of bank lending, house prices slumped by more than 7 per cent in 2007. Goodbody Stockbrokers predicts the price slump will accelerate to 8 per cent this year, but nobody knows when the market will hit bottom.

Of course, the Republic has a long way to go to match Japan's dizzying fall. The Nikkei stock average plummeted by a staggering 80 per cent from the 38,916 recorded at the tail end of the 1980s. Today, it hovers at about two-thirds that peak. Japanese property prices have only recently started to rebound after plunging for 14 straight years, in some areas by 80 per cent. Japan's total land area is today worth less than half the $18 trillion recorded in 1991.

In hindsight, economists say this calamitous downward spiral was the result of unique factors, unlikely to be repeated in Ireland or anywhere else. "I'm very reluctant to believe that Japan's experience can teach anybody, anything anywhere," says Kevin Gardiner, head of global equity strategy at HSBC in London and the man given credit (or blamed) for coining the term Celtic Tiger. "It is just a very unique economy."

Bubbles hurt, though, wherever they pop, and Ireland has experienced a whopper. As the Economist notes: "The rise in prices in Japan during the decade before 1991 was less than the increase over the past 10 years in most of the countries that have experienced housing booms," including Ireland.

It is the Republic's head-spinning rise in property prices - about 270 per cent since 1996 - that invites the strongest comparisons, and makes the country one of the most expensive housing markets in the OECD.

Because this rise almost exactly mirrored the crash in Japanese property values, Ireland has left the world's second largest economy behind. According to the 2006 international housing affordability survey by research firm Demographia, the price of a middle-class home in Dublin would now pay for almost two in Tokyo.

Of course, the parallels can only be stretched so far. Apart from the very obvious differences and size and profile of the two countries, Japan's giant corporate sector - not the home property market - was the motor for its overheating economy. Many corporations had large, wildly inflated real estate holdings in the 1980s, often financed by paper profits from the levitating stock market. Banks and corporations stoked the rise in property and stock prices further by using them as collateral for further loans and speculation.

"When the crash came, they were hugely exposed," says Takuji Okubo, senior economist at Merrill Lynch Japan Securities.

"Falling property problems shouldn't be a catastrophic problem, if contained in the household sector. Consumption will fall and there will be pain for many households, but most will somehow pay back their loans. But when companies have large holdings, it does involve serious problems, especially when they have fallen into negative liquidity. The problem in Japan was companies had sizeable real estate, so this added to balance sheet problems."

Ireland's problems, say analysts, while painful for many ordinary households, are more contained. "The Irish banks do make a lot of their money from lending to the property market, so understandably they're worried," says Gardiner. "But apart from the banks and large insurance sector, I think exposure to the property market in Ireland is modest." The bottom line is, though, that borrowers in Ireland and Japan were encouraged to believe that property prices could continue forever, and now they are dealing with the hard truth: gravity wins. So here are some of the most important lessons from the Japanese crash:

1:Quickly grasp the policy nettle when the crisis starts. Most economists now concur that Japan's government and Central Bank were sleeping at the wheel when the property and stock bubble burst, then made the wrong decisions once they woke up.

The Bank of Japan's key interest rate stayed high - at 4 per cent - even as the slumping property/stock market became obvious in the early 1990s. It wasn't until the end of the decade and after the Asian financial crash of 1997/8 that the bank introduced its zero interest policy in a bid to kick-start borrowing and spending. By then it was much too late: deflation had set in and the economy was in deep freeze.

With control of Irish interest rates ceded to Europe, the Government should be mindful of Japan's mistakes, says Graham Davies, director of the Economist Intelligence Unit in Tokyo. "What happened in Japan was that they were too slow to cut rates and when they did it was too late to have an impact, even when they flooded the economy with money. Ireland could experience that double whammy: slow to cut rates and the rate cuts don't have an impact."

2:Weak accounting standards and poor regulation prolonged Japan's misery. Japan's banks and corporations hid losses on their balance sheets throughout the 1990s because, well, they could. Year after year, slack regulations allowed them to shift declining assets around and record older prices for stock and property holdings, artificially inflating their value and postponing the day of reckoning.

"The lesson is that if stricter accounting had existed, the companies would have gone bankrupt instead of remaining in the market and depressing productivity in the overall economy," says Takuji Okubo. In addition, he says, there was no legal procedure to deal with banks going bust, because nobody expected that to happen. "In 1997/98, parliament was passing laws to deal with the banks as they went bankrupt." He says the question then for Ireland is: does it have its regulatory house in order?

3:Don't panic. Anne Lanigan, director of Enterprise Ireland in Tokyo, has two pieces of advice to Irish planners: consolidate your strengths and don't panic. "The lessons that Ireland can learn from Japan are not to over-dramatise the problem. Everybody made such a big deal about what was happening here that it led the rest of the world to write off Japan for a decade."

She believes the downturn in both countries was necessary. "It got crazy here in the 1980s, like Ireland, but the truth is that most people are better benefited when things settled down. We should focus on the strong parts of our economy. In Japan it is manufacturing, it could well be agriculture in Ireland, because there will be a shortage of food and commodities in the world from now on."