Japan's credit lessons: act fast, expose all losses

But Japanese economists are alarmed by calls for changes to accounting rules that would limit credit-related write-offs.

They say efforts to conceal the real magnitude of losses proved self defeating in Japan's case, resulting in the "lost decade" of economic stagnation, deflation and falling asset prices.

At the core of the current crisis again is the difficulty investors and bank risk managers have in putting a value on complex credit products, such as collateralized debt obligations (CDOs) as trade in them shrivels.

The Institute of International Finance, a global financial services association, last week called for a review of accounting standards that force banks to put a price on their assets, saying that could spark a downward spiral.

Fed Chairman Ben Bernanke also said last week that mark-to-market accounting had helped destabilize markets for illiquid assets, although he stopped short of calling for a change in the rules.

But Japanese economists argue that their country's experience shows that in the long-run even the harshest truth about the scale of the problem is better than nagging uncertainty.

An experiment called the Ellsberg Paradox illustrates the point.

In the experiment, two urns are filled with red and black balls. One has 50 of each color while the second holds 100 balls, but the number in each color is not known.

People told to pick out a red ball from either urn overwhelmingly choose the first urn, even though the second could have had more red balls.  Continued...