U.S. policy makers have learned some, but not all, of the lessons to be gleaned from Japan’s lost decade, says TD Economics in new report.

In particular, the U.S. needs to address the broken mortgage market, or economic recovery will remain elusive.

TD says that the U.S. clearly learned some lessons from Japan’s experience. In particular, the Federal Reserve Board eased monetary policy quickly and deeply, and it has embraced unconventional policy when conventional policy was exhausted. “These actions helped to revive the U.S. financial system and foster a recovery,” it notes.

However, TD says that one important lesson has not received adequate attention. “The stagnation in Japan was partly due to the fact that financial intermediation remained impaired for many years,” it says. “The remaining lesson from Japan is that U.S. authorities must address the ongoing foreclosures crisis, and this likely requires radical mortgage reforms.”

TD says that Japan’s failure to tackle the consequences of its financial crisis on the banking system “was a major contributor to the protracted recovery and the deflationary trend.”

In the U.S., TD says, there is a “massive cloud of non-performing loans” hanging over financial markets. “It is here where a lack of resolution threatens the speed of recovery in the financial system and the U.S. economy.”

TD reports that at the end of the second quarter, 4.6% of mortgages were in foreclosure and another 4.5% were 90 days past due but not yet in foreclosure; representing more than 4 million delinquent loans. “Rising non-performing mortgage loans are not only affecting financial institutions, but are also proving to be a constraint on labor mobility, as unemployed people find it difficult to sell their homes to relocate in search of a new job. This effect is contributing to inertia in the housing market, stalling the improvement in sales and prices,” it says.

“The lesson from Japan’s lost decade is that allowing non-performing loans to linger for an extended period on financial institutions balance sheets hinders the functionality of the banking system,” it says.

However, solving the problem won’t be easy, it warns, as this involves homeowners, lenders and mortgage brokers, loan servicers, underwriters of mortgage-backed securities, title insurers, buyers of securitized mortgages, rating agencies, the government sponsored enterprises Fannie Mae and Freddie Mac, government regulators, and the judicial system.

“The choices to addressing mounting foreclosures are limited and all appear fraught with potential unintended negative consequences,” TD says. “Yet, if we have learned anything from Japan’s lost decade experience it is that not directly tackling the root financial problem (i.e. the foreclosure crisis) could be the costlier alternative by perpetuating an extended economic recovery cycle of weak economic activity.”

“U.S. authorities must grab the foreclosure crisis by the horns, where the ultimate solution appears to lie in radical mortgage reform,” it says. “Markets must recognize that the Fed alone cannot offer all the solutions. If anything, the low interest rate environment created by quantitative easing may have bought some time for authorities to piece together alternative solutions to the housing woes. But make no mistake, if the escalating foreclosure problems are not directly addressed, weak economic growth will become the order of the day for many years to come.”

IE