Now Is The Time For "Strengthening Japan's Financial Sector"

Kazuhito IKEO (Professor, Keio University)

Improving the competitiveness of the financial and capital markets is one of the important policy issues that Japan has long been pursuing. Actually, late last year the Financial Services Agency finalized the "competitiveness strengthening plan" as a roadmap for dealing with that issue, where the author actively participated in the discussion to finalize the plan.

Along with the current financial crisis originating in the U.S., however, there seems to be increasing argument in Japan that the idea of "strengthening the financial sector" itself is wrong in the first place.

Even in the U.S. that kind of argument could be heard, as one may guess from Robert J. Shiller's writing in his recent book "The Subprime Solution" (http://press.princeton.edu/titles/8714.html) that "there are those who imagine that the entire solution to the subprime crisis is in either sidestepping or punishing the financial sector" (p. 173). But, Shiller says in his book that such an argument is erroneous, and it is necessary to facilitate the development and the functions of the financial and capital markets for larger constituencies as a fundamental solution to the possible recurrence of the financial crisis that we are facing now. In other words, the current crisis may be due to remaining deficiencies and less than fully developed factors in the financial and capital markets.

Especially in Japan, there seems to exist a misconception that risky transactions themselves are not desirable. Such a conventional view that even refers to derivatives as a "villain" is widespread. These views are exactly opposite to the position of Shiller, who is proposing the creation of new markets for derivatives to hedge various risks in housing and other daily activities as part of the solution to the subprime problem.

The author, strongly agreeing with Shiller's argument, would suggest that such financial vehicles as derivatives and securitization could be better understood if they are compared to automobile. That is to say, financial vehicles, just like motor vehicles, are basically an instrument to expand the possibility of our activities and thereby make our daily life more comfortable.

Unfortunately, traffic accidents with some fatalities could happen. But we seldom hear the argument that refers to automobile as a villain. If the accident is caused by some mechanical flaws of the automobile itself, then that should be fixed immediately. Some accidents are a result of reckless driving. Then traffic laws and regulations should be revised with more stringent punishments to control such bad driving habit. Also, infrastructure improvement such as installment of more traffic signals and signs may be necessary.

Similarly, in the case of financial instruments, any flaws in product design should be fixed immediately. If the behavior of product organizers or investors is reckless, the surveillance system must be reviewed and strengthened to discipline them. Also, it is indispensable to inspect and improve the information infrastructure of the financial and capital markets such as credit rating agencies.

One should realize that, while these measures are intended to prevent the financial crisis from happening again, they may be regarded as a step toward "strengthening the financial sector." In other words, the current financial crisis has made the strengthening of the financial sector all the more necessary, but not less.

If there are no opportunities to reallocate risks, no firm or household would dare take any risk, resulting in a stagnant economy. Therefore, the right thing to do is not condemn risky transactions themselves, but provide the environment in which risky dealings can securely be made.

(The original Japanese article appeared in the December 20, 2008 issue of Weekly Toyo Keizai)