Japan provides "a lesson ... in what not to do" in financial crisis

How do we avoid becoming another Japan?

That question has prompted U.S. officials to move aggressively in recent weeks as they seek to save the American financial system while avoiding the kinds of regulatory pitfalls that plunged Japan into economic quicksand almost two decades ago. Although the world's second-largest economy buckled during a collapse of its real-estate and stock markets, it was, many analysts say, government mismanagement that made the crisis even worse.

The result was a diminishing of Japan's economic power and global influence lasting to this day. After falling 66 percent from 1990 to 2005, Japanese housing prices have climbed back to only 40 percent of their 1990 values. Tokyo's key Nikkei stock index remains a dim echo of its former self, still 70 percent off its 1989 high.

Now, U.S. officials, who long argued that the Japanese needed to be more aggressive and hands-on, appear to be practicing what they preached. Aided by a far more transparent financial system that has made it more difficult for U.S. banks to hide the extent of their bad bets, regulators have accelerated a reckoning for some of the most vaunted names in American finance, generating a historic upheaval on Wall Street. The effect, leading analysts say, could ultimately be a briefer bout of economic pain than what the long-suffering Japanese have had to endure.

"The U.S. is moving in dog years compared to Japan," said Adam Posen, deputy director of the Peterson Institute for International Economics and a former consultant to the U.S. government on the Japan crisis. "Every one year of action here is about equal to what it took Japan seven years to do."

The sharply different U.S. approach is no coincidence.

American regulators have been actively seeking advice from Japan, hoping that a better understanding of its mistakes will aid them in navigating their own country's financial crisis. Advice has largely come during frequent talks over the past year, during which U.S. financial officials met with their former and current counterparts in Japan.

Critics say Japanese regulators wrote the book on how not to handle a financial crisis, at first refusing to admit a problem, then moving slowly — often ineptly — when they did.

It is too early to gauge whether U.S. efforts will ultimately prove more effective than those taken by the Japanese, and economists on both sides of the Pacific warn that the biggest tests probably lie ahead. Analysts are questioning the health of regional and midsize banks across America, and many economists are reserving judgment until they can assess how aggressively U.S. regulators move to force complete disclosure of bad debt and consolidation within the industry.

But the Japanese say they have marveled at the relative speed at which U.S. regulators have moved recently to sell off Bear Stearns, encourage market solutions for Merrill Lynch and Lehman Brothers and take over mortgage-finance giants Fannie Mae and Freddie Mac. By comparison, the Japanese came under heavy fire in the 1990s for allowing bad debt and ailing banks to linger for years.

The Japanese financial crisis was at once strikingly different and hauntingly similar to the one facing the United States. Both countries were slammed by the bursting of real-estate bubbles and the need to address the resulting bad debt left to banks.

A key difference is that the Japanese real-estate bubble was based more on the rise of commercial real-estate prices and their links to corporations. Japanese firms became deeply entwined with highly speculative development projects, zapping those companies of market value as the reality of their folly became clear. A year before the real-estate bust in 1990, Japan suffered a far more devastating stock-market bust.

Yet Japan's fatal mistake, economists now mostly agree, was regulators' refusal to confront the stockpiled bad debt and in some cases encouraging banks to hide it. Such decisions not only sickened the banks and their clients further by allowing bad debt to get worse but also inhibited those banks from making fresh loans to healthy companies.

Though Japan's economy appeared to get back into a groove in a prolonged expansion that began in 2003, real-estate prices and the stock market never really did.