America follows Japan's misguided path

By Bill Fleckenstein

When Japan's Ministry of Finance last week stated that (a) "the subprime issue won't have an impact on the U.S. economy" and that (b) "Japan reserves the right to intervene in currency markets," I was really irritated.

The yen's modest strengthening to 118 yen to the dollar obviously got the attention of the authorities there -- as if they know anything about spotting potential credit implosions or don't have a weak enough currency already.

It got me to thinking just how much the world has changed, and not for the better, due to the irresponsible behavior on the part of the Bank of Japan and Alan Greenspan's Federal Reserve over the past 20 years or so. Thus, given all our problems related to debt, I thought it might be worthwhile, particularly for new readers, to provide a brief history leading up to where we are now.

Taking a big step back, the Bank of Japan acted foolishly throughout the 1980s, which caused that country to experience enormous real-estate and stock bubbles. Japan's stock bubble was really a residue of its real-estate bubble -- actually a credit bubble, as the banks lent money to any corporation with a pulse. (Does that sound familiar?)

Then the institutions that lent the money took forever to write off the bad loans. That's why Japan's real-estate market, stock market and economy did so poorly for more than a decade.

Free money exacts a price

Here's why that matters to us, other than for the lesson it offers on bubbles (which our Fed has been unable to learn): After Japan's problems, that nation's central bank kept interest rates at virtually zero for the better part of a decade. That essentially-free money has been part of the reckless lending and misallocation of capital that has proliferated around the planet.

I'm not going to recount all the mistakes made by Greenspan that precipitated the late-1990s equity bubble -- which, suffice to say, was the biggest our country has ever seen.

After that bubble, Greenspan took a page out of the Bank of Japan's book and lowered rates to 1%. That helped precipitate the housing bubble here that ended in 2005.

Synthetic paper, genuine loss

As to why the unwinding has taken so long to commence, only recently has the cause become clear: the mark-to-model fantasy employed by those who have bought the sliced-and-diced mortgage paper.

But the fantasy is unraveling as these structured-credit products are now slowly being marked to market. Just as virtually every subprime-mortgage lender has blown up, Alt-A lenders (the next rung up the ladder creditwise) will blow up -- and, ultimately, many hedge funds will blow up, though we're in the early days of that process.

In the years since our equity bubble peaked, trillions of dollars' worth of debt have piled up throughout corporate America. So now, as we enter recession, we will experience not just a weak economy, real-estate market and stock market, but the exacerbating effect of a mountain of bad debt, completing the analogy to Japan of the 1990s.

Complacency is not a strategy

It's important to keep in mind that trouble can take so much time to unfold that you can get fooled by recent trends. For instance, strong stock prices over the past couple of years have caused so many to be so complacent regarding our current credit problem that when trouble hits, folks don't recognize it for what it is.

The mainstream news media and Wall Street aren't interested in the big picture. Those are the folks who said subprime is not a problem. Then they said it was contained and that it wasn't going to spread. Now that supposedly higher-quality Alt-A loans are a problem, they're saying the same thing.

• Video: Winners in the subprime mess

Eventually, they're going to find out that there's a problem in all mortgages, because people overreached to buy houses they couldn't afford, because they believed the price would go up, as did the lenders, which is why anyone with a pulse could get money.

Hopefully, this synopsis will help readers see how the misguided money-printing policies of two central banks have created a world fraught with financial risk, even as those policies have made Wall Streeters fabulously wealthy.