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Japan's Desperate Deals


International Business: Japan

Japan's Desperate Deals

They're just the prelude to even greater upheaval

Old Japan hands thought they would never see such deals in the closed world of Japanese finance and business. U.S. financial giant General Electric Capital Services Inc. pulls off a $6.5 billion takeover of Japan's biggest leasing company in the country's largest foreign acquisition ever. Goodyear Tire & Rubber Co. suddenly emerges as Sumitomo Rubber Industries' white knight. Keiretsu group relationships fall apart as Japanese banks and brokers engage in a bewildering array of novel mergers and tie-ups. The financial-reconstruction czar, Hakuo Yanagisawa, forces a shotgun marriage between Mitsui Trust & Banking and rival Chuo Trust & Banking.

These deals are a prelude to an even greater upheaval. It's not because Japan's mandarins want reform: They probably don't. Instead, the transformation will occur because Japan's trillions in wealth are a far weaker bulwark against change than anyone has imagined. Japan is running out of money to prop up its bankrupt banks and companies and absorb at least $600 billion in bad loans. The only solution is to weed out weak companies and invite in foreign capital. "Only companies in real distress would look at such deals with foreign partners," says Mitsubishi Corp. Chairman Minoru Makihara.

Skeptics think these deals are window dressing, an attempt to convince gullible foreigners that Japan is serious about reform. They argue that with $10 trillion in domestic savings and $1 trillion in net overseas assets, Japan can resist real reform for years. Yet the fear is growing that the government cannot continue to bail out sick companies. Prime Minister Keizo Obuchi's government thinks it can readily raise $500 billion for fixing the banks and earmark another $200 billion in easy credit to companies, tax breaks to consumers, and public works to benefit the sprawling construction industry. Yet raising that money could prove prohibitively expensive. Even if Obuchi pulls it off, this budget may be the last serious rescue package the government can afford: As little as $1 trillion of Japan's $11 trillion in wealth may be available to bail out Japan Inc.SPOOKED. It's hard to square this parlous state of affairs with the stories of Japan's wealth. Couldn't Tokyo just tap into those trillions by issuing an endless stream of government bonds, then bail out banks and companies with the proceeds? That's what the government hopes to do--but investors are already getting spooked. Long-term rates have doubled since last fall, as bond traders wonder how a projected 50% increase in bond issues will be absorbed by the market. MOF's Trust Fund bureau, which manages $3 trillion in postal savings and insurance premiums, says it can't absorb the new demand.

Some politicians want the Bank of Japan to print money to buy all these bonds. That's a scary idea, since years of wasteful public-works spending have driven up Japan's gross debt level to 110% of gross national product. It could reach 140% by 2002. This estimate does not include the latest bank bailout plan--and billions more in off-balance-sheet government loans and pension shortfalls. "The real millennial time bomb [is] the collapse of Japanese government finances," warns David Asher, a research fellow at Massachusetts Institute of Technology.

To understand why, you need to deconstruct the quality of Japanese assets. It's true that Japan holds $1 trillion in net assets overseas, and theoretically, it could bring that money home. Yet roughly $800 billion of that is owned by companies in the form of private direct investment, such as real estate, factories, and securities. Much of that money is off the table. The government can't really ask Toyota Motor Corp. to sell off a truck plant in Indiana and invest the proceeds in Japanese government bonds. And a big chunk of this money is sunk into Asian factories. These plants have lost much, if not most, of their value and some of the loans backing them have gone bad.

Meanwhile, the balance of that $1 trillion, some $220 billion, represents the foreign-exchange reserves of the Bank of Japan, most of it parked in U.S. Treasuries. Yet BOJ needs these dollar reserves as ammunition in its periodic fights to influence the strength of the yen. The upshot is that Japan's overseas assets will be of little use as the funding crisis grows at home.

The other pots of money in Japan can't help bail out the system, either. MOF's Fiscal Investment & Loan Program, or Zaito, has historically channeled some of the $3 trillion in postal savings into the government bond market. Now, that money is earmarked for emergency loans to the corporate sector and won't be available for the bonds that the government desperately needs to sell. Nissan Motor Co., for example, received a $730 million loan from the Japan Development Bank.

Worse, some $1 trillion in postal savings deposits are parked in long-term certificates earning 5% on average. Those certificates expire soon. Because deposit rates have fallen to 1% since 1995, "maybe half of that will be withdrawn," frets one senior MOF official. That means the government will have much less money for bailouts.

Finally, Zaito has lent much of the postal savings funds to questionable infrastructure and real estate projects. Analysts figure Zaito has to write down or write off a third of that sum, given the drastic decline in property prices. MOF vigorously denies there is a bad loan problem at Zaito. But Merrill Lynch & Co. economist Ronald Bevacqua notes that Zaito is projecting a $28 billion decline in income for loan repayments this year--a sure sign of trouble.

The $3 trillion on deposit in the postal savings system is one third of Japan's $10 trillion in household financial assets. The authorities can conceivably draw against this $10 trillion in the fight to save Japan Inc. Yet that number quickly dwindles on examination. The postal savings money is already tied up in the Zaito mess. Households have another $3.5 trillion worth of home mortgages and other debts to service. The remaining $3 trillion is sitting in other banks. The Japanese are hoarding this money against shortfalls in private and public pension schemes that are projected to hit 100% of gross domestic product. The banks are reluctant to put these funds into government bonds.FAMILY SILVER. The mismatch between assets and liabilities is alarming. "These numbers have never been witnessed before in an industrialized economy," says Vincent Truglia, a former New York Fed official and managing director of rating agency Moody's Investors Service. To get government funds before they disappear, banks that once vowed to remain independent are merging. Companies are unloading the family silver. Japan Airlines Co. decided last month to sell its trophy Essex House in midtown Manhattan for $250 million to Chicago-based Strategic Hotel Capital. At this scary stage, foreign money is looking more attractive. "If a foreign bank buys a Japanese bank, it's more safe," says Citizen Watch Chairman Michio Nakajima.

That's ironic. Finance ministers in the West have hectored the Japanese for years to get tough on reform. It never did any good. But the prospect of running out of money has given the Japanese a focus they long lacked. They need to keep that focus to avoid possibly the worst solvency crisis in Asia. It will be a long and painful workout.By Brian Bremner in TokyoReturn to top


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