It's Koizumi vs. Japan's Broken Banks


By Brian Bremner After feinting left and right for months about his plans to fix Japan's banking mess, it's show time for Prime Minister Junichiro Koizumi. In the next several months, his economic-policy crew will have to produce a credible plan to get the crisis under control. By credible, I mean one that imposes realistic deadlines, clears dud loans off the books of Japanese banks once and for all, and gives voters a clear idea of what it will cost them.

So far, the Koizumi government has pledged to get the job done in three years but has offered only a vague outline of how the workout will proceed. It has also insisted that Japanese taxpayers won't have to shoulder any additional costs. After all, the government already has pumped some $70 billion of capital injections into Japan's biggest banks. That was supposed to do the trick. It didn't come close.

STORY BEHIND THE STORY. The reason? The banks have basically been playing an accounting game in which they shore up the loan-loss reserves but fail to take the additional step of writing off the loan entirely -- instead cutting off deadbeat borrowers, seizing what collateral they can, and selling it off for whatever they can fetch. The government, even though it received preferred shares in exchange for that $70 billion, acted like pussycats during the whole charade.

Well, here we are in mid-2001. The credit-rating agencies are treating Japanese banks like pariahs once again. The Nikkei's collapse is hammering the stock portfolios of Japanese lenders, which in turn undermines their capital base. Japan's Financial Services Agency reported on Aug. 2 that problem loans at banks nationwide are now roughly $262 billion. Some private economists think it's actually far worse than that, perhaps amounting to $600 billion or more. On top of that, with the economy in a recession, more and more loans likely will turn bad.

As a new report by Nikko Salomon Smith Barney points out, "banks have only enough resources to write off the tip of the iceberg of existing bad debts." In other words, the problem has now grown so critical that the amount of dud loans far exceeds banks' existing loan-loss reserves and operating profits. The upshot: The government, or taxpayers, will need to make up the difference if the job is going to get done.

TIME TO SPIN. It's time for Koizumi and his team to come clean. They haven't been entirely up-front with the public about this. One reason is that his new government had to consolidate its power in the just completed Upper House elections in the Japanese Diet. An expensive rescue mission for the banks isn't exactly a vote-getter. But now Koizumi and his ruling Liberal Democratic Party triumphed, and they have a mandate. He continues to enjoy almost cultlike status with ordinary Japanese.

It's also time for Koizumi to spend some political capital, taking on one of the toughest economic challenges in the industrialized world. His dilemma is that another free lunch for Japanese banks, like the one in 1999, would make him look politically weak. Worse, it likely wouldn't work. Without some form of government support, many Japanese banks simply don't have the financial firepower to clear their loan books.

What can he do? Koizumi's economic triage unit must package its bank bailout plan in just the right way. The trick will be in strengthening the role of the Resolution & Collection Corp., which has been buying troubled loans from banks on a modest level since 1999.

GOVERNMENT APPEAL? The RCC has been a very tough negotiator. Of the nearly $8 billion in loans it has bought, it has paid just a fraction of the face value of the original loan -- so the banks take a huge hit when they sell the loan. That may strike some as just punishment for shoddy lending practices that caused the banking crisis in Japan.

But fixing Japan's banks isn't a morality play. The banks need some sort of economic incentive to sell their loans to the RCC. A better idea might be to shore up the resources of the RCC with government money, at least indirectly. One idea being floated is to have the RCC's owner, which in Japan is the Deposit Insurance Corp., issue bonds and use the proceeds to accelerate its loan purchases, offering more generous terms.

The RCC would offer above-market prices even if the true value of the loans didn't justify it. Perhaps the government would absorb half the losses, and the banks would take the haircut on the remaining 50%. In theory, the banks would then be able to clear their books of bad loans and get back into the business of lending.

TIME TO GET REAL. Of course, the danger is that, with Japan's already monstrous budget deficit, a flood of new government-backed bonds to shore up the banking sector would trigger a collapse of the bond market. However, the Bank of Japan might agree to increase its purchases of Japanese government bonds on a temporary basis to keep liquidity flowing into the market.

The rosy scenario is that the Japanese economy would recover, stock and real estate prices would improve, and the RCC would be able to sell its loans and collateral in a few years' time and limit the hit to the public coffers. This is the approach that the U.S. government took to fixing the savings and loan debacle in the late 1980s and early 1990s. And it worked -- more or less.

Japan's road will be rougher. Its banking problem dwarfs the S&L crisis. And a full-fledged recovery is still years away. However, at least Japanese taxpayers this time would be spending money on a plan that has a strong chance of working -- unlike the no-strings-attached approach in 1999. Japan isn't part of a perfect world, and fixing the banks will be expensive, but Koizumi would be wise to start talking straight to his adoring public about how much it may take. Bremner, Tokyo bureau chief for BusinessWeek, offers his views every week in Eye on Japan, only for BW Online


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