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Caution: Zombie economy just ahead

POSTED: February 25, 2009 9:33 a.m.
Computer hackers managed to hijack a digital road sign in Austin, Texas, a few weeks ago and change its message to “Zombies Ahead.”
It was a whimsical warning for that stretch of Texas road, but could have served as a deadly earnest statement about the U.S. economy. “Zombie banks” was the term for Japanese financial institutions propped up by government in the 1990s despite their basic insolvency after a real-estate bubble. These unprofitable banks, in a financial revenge of the living dead, cast a decade-long pall over Japan.
At the time, American officials like President Barack Obama’s economic guru Larry Summers urged the Japanese to give up on failed institutions. Instead, Japan pumped 12 percent of its gross domestic product into saving the banks and got a “lost decade” of economic stagnation in return. Economic analysts across the board agree that the Japanese example must not be repeated, even as our lawmakers stumble into repeating it.
Members of the House Financial Services Committee flogged eight banking chief executive officers the other week, apparently without considering that some of them were already dead men walking. The CEOs were grilled about their lending practices and bonuses, when they should have been asked, “Why does your company still exist?”
The awful truth is that the financial system has at least another $1 trillion hole in it. Either the U.S. government has to continue to try to patch it over with massive –– and perhaps ever-escalating –– injections of money a la the Japanese in the 1990s, or it has to take the painful, risky step of letting some of the big, irreparably wounded financial players go down. Neither choice is appealing, which is why Treasury Secretary Timothy Geithner trotted out his muddle-through, we’ll-get-back-to-you-on-details rescue plan.
As it stands now, the U.S. government is keeping alive banks that would otherwise go bust at the same time it is hectoring them about lending more money –– in other words, Japan redux. Tokyo short-circuited the natural churning of the capitalist system that is the only way to clear out failed companies and unproductive uses of capital. If the U.S. government keeps alive Chrysler and General Motors or Citigroup and Bank of America when they are no longer viable –– and have rendered themselves such through poor business choices and foolish risk-taking –– it will create a zombie economy without the capacity for self-renewal.
The financial system, of course, is fragile. We have learned that the uncontrolled collapse of an institution like Lehman Brothers is dangerous. Bankrupt banks that are truly “too big to fail” need to be taken over by the government, broken up until they are small enough to fail and sold off, with government eating their toxic assets for now. This kind of seminationalization can clear the decks for new, healthy banks that won’t be long-term wards of the government or long-term drags on growth.
During the stimulus debate, Obama often cited Japan’s cautionary example. But Japan tried a big stimulus, too, even as it left in place its zombie banks. Will Obama heed his own admonitions?

Lowry is editor of the National Review.
 

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