It looks like crisis time again in Tokyo. Industrial production, housing starts, consumer prices, and employment all collapsed in January. Fourth-quarter economic growth is expected to come in at just 0.6%. The U.S. slowdown is hitting exports. While the Nikkei has rebounded recently, it remains at historic lows. Scariest of all, the stock portfolios of Japan's indebted banks are getting creamed.
Add it all up, and it's easy to understand why some see a reprise of the 1998 upheaval that wiped out major money-center banks and brokerages, while shoving the economy into its worst recession of the postwar period. On top of that, the Liberal Democratic Party-led government, burdened by the unpopular Prime Minister Yoshiro Mori and facing a tough general election this summer, seems incapable of leading the country out of the morass. "They aren't showing any vision for the economy," laments Yukio Shohtoku, managing director for international operations of Matsushita Electric Industrial Co.
NEW PHASE? Japan's back is against the wall, all right. But there is good news too. The financial market reforms enacted over the past few years seem to be taking hold, a process that probably can't be stopped. The current upheaval is part of that--and may ultimately force banks and companies to mark assets to market, zap fake collateral, and sell depreciated assets to raise cash. This may at last be a truly new phase in Japan's financial evolution.
Skeptics say they've heard it all before, but there is evidence that things have really changed. For one thing, the banks are far stronger. Since the crisis of 1998, the government has pumped $61 billion into big lenders, replenished the deposit insurance fund, and sold large and small lenders. True, banks are taking a hit on their stock portfolios, and are expected to write off $10 billion in debt this fiscal year. But that's a quarter to one-third of what they wrote off in 1998, says Takashi Kiuchi, economic adviser to Shinsei Bank Ltd.
Moreover, hard as it may be to believe, positive forces are partly responsible for shaving 2,000 points off the Nikkei last April. Yes, fears of declining exports in the event of a U.S. recession are hurting stocks. But the banks are also dumping their cross-share holdings--the stock positions they've held in their clients' companies for decades. Doing so frees up capital for more rational investments and makes it easier to cut off deadbeats, who have relied on their equity linkups with the banks to get their loans rolled over.
There is a catch. Banks are selling in a rush, because for the fiscal year ending Mar. 31, they must for the first time mark equity holdings to market, rather than original cost. With some banks sitting on big stock losses, they are hurrying to sell before they lose even more. Although less harmful to big banks' capital bases than in 1998, these losses will crimp earnings and the ability to provision against bad loans. Worst hit will be Chuo Mitsui Trust & Banking Co. and Toyo Trust & Banking, says J. Brian Waterhouse, an HSBC Securities analyst. Some small banks might even go under.
Although in theory the banks need not report portfolio losses publicly until they close their half-year books in September, the Bank of Japan is clearly worried that fears of a banking crisis will further spook investors. That's why it cut the overnight call rate by 10 basis points on Feb. 28, to 0.15%, and the official discount rate by the same amount to 0.25%. Cheaper money makes it easier for investors to borrow to buy stock. The central bank also says it will offer generous loans to banks in trouble.
Is this shaping up to be the kind of pain-free bailout the Japanese excel at? Not if BOJ Governor Masaru Hayami can help it. He is unlikely to do more for the banks unless they get serious about cleaning up their act. Ditto for Japan's financial watchdog, the Financial Services Agency, headed by Hakuo Yanagisawa. He is pressing money-center lenders to get dud loans off the books by 2003. So far, most have simply set up additional reserves against bad debt. That means the loans linger in some form on banks' books, and borrowers aren't cut off from fresh credit.
In contrast to these half measures, Yanagisawa wants banks to write the loans off completely, seize collateral, sell it for what it will fetch, take a big earnings hit, and clear the books. HSBC's Waterhouse reckons the government's Resolution Collection Corp., which has focused on buying bad loans from small banks, could be employed to take on dud loans from bigger banks too. That would be handy politically because the BOJ, not taxpayers, would fund the write-off.
Such harsh medicine has grave implications for Japan's overextended corporations. Once officially declared in default of their old loans, companies will have to restructure their way to profitability to qualify for new credit. Although new accounting laws that take effect in April will make it easier for companies to cut loose struggling units, some won't. And the downsizing required, particularly in crowded industries like construction, retailing, shipbuilding, and autos, would drive up Japan's record 4.9% jobless rate to 6% or 7%. It would also accelerate a record run of bankruptcies, as well as depress stock and land prices in the short term.
The question is whether Yanagisawa and Hayami will prevail. The BOJ is under pressure to underwrite another spending package. Should Mori's Cabinet quit in coming weeks, Yanagisawa could be replaced with someone more pliable. Still, even LDP conservatives see the wisdom of forcing banks to take stronger action. That's because unless they start lending to fast-growth sectors, a recovery is out of the question.
MARKET REBOUND. Yanagisawa hopes to win government approval this month for his plan to purge the system of bad debt by 2003. He has hinted that regulators will tolerate losses, so long as banks get serious about retiring bad debt. Yanagisawa thinks his approach won't cost taxpayers any more money. Others aren't so sure. ING Barings bank analyst James Fiorillo believes $85 billion more of taxpayers' money will be needed to cover earnings losses as banks take the plunge.
All in all, it will take years to complete the needed workout for Japan's bloated industries and lenders. But until the banks' balance sheets are fixed for good, "the whole economy will suffer," says Masayoshi Son, president of Softbank Corp., which owns 48.8% of Aozora Bank, the former Nippon Credit.
Goldman, Sachs & Co. economist Kathy Matsui notes that once a serious workout began in the U.S. savings and loan crisis in 1989, a market rebound drove share prices up 50% over the next five years. For Japan, only a hopeless optimist would predict such a trajectory. But sometime in the next few months, the government and the banks have a chance to map the road to recovery. Japan simply has no other choice.
By Brian Bremner and Ken Belson in Tokyo
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