Banking disasters in other markets could help us understand the one we have here now.
In the 1980s, Japan was awash in economic success. The Rising Sun established itself as a technological powerhouse, and the local economy was bustling with opportunity. Real estate prices went through the roof, and Japanese banks loaned money to anyone who asked, secured against inflated property values.
Then, reality caught up with the boom. In the early 1990s, home prices crashed, and the Japanese government took a defensive approach to avoid a huge financial crisis. The federal lending rate was cut to zero, and the government bought large stakes in failing banks. But it didn't work.
The Japanese economy may have avoided a severe crisis of confidence by these measures, but what came instead was arguably much worse. Long years of deflation stacked atop low economic growth meant that Japan's Gross National Product was the same in 2003 as it had been in 1995-seven years of fruitless effort. The Japanese government started raising interest rates only recently, and some might say that the "lost decade" is still going on.
Counterpoint on the other side of the world
In stark contrast to Japan's recession, Scandinavia went through an economic crisis about the same time. But where Japan chose the softer way out and ended up in a lengthy economic downturn, the Nordic nations took their bitter pills quickly and worked out their disasters in a few short years.
Sweden, Finland, and Norway stepped in with higher interest rates, at one point as high as 500 percent, to discourage bad lending. They took over failing banks wholesale, posting government guarantees for unpaid debts, and boiled down sprawling banking systems to just a handful of strong banks under tighter regulation. Then, the rejuvenated banks were spun out on the public markets again, giving the governments direct returns on their investments.
The U.S. response to the housing meltdown of the past two years has been a compromise between the extreme solutions of Japan and Scandinavia. The government is injecting cash into a shaky banking framework, selling treasury bonds to support these investments. That's Nordic.
On the other hand, federal lending rates are going the Japanese way, hovering just above the 0 percent mark. Large banks, like Wachovia and Washington Mutual, have been guided into mergers with healthier banking giants rather than seized and restructured by the government itself.
The Scandinavian response seems more appropriate for America's crisis. Like citizens in the Nordic countries 20 years ago, the average American isn't saving much money-whereas Japanese savings were in good shape at the start of that recession and could therefore withstand a bit of deflation.
It's too early to tell exactly where we're going under a new government that's dramatically different from the one in power during this meltdown. Here's hoping that America gets closer to the sharp but short-lived pain seen in Northern Europe than to the long, slow agony of the Far East.