It's clear that Tokyo officialdom has grown too fond of those blue pills. They're still in denial about the true depths of the country's seemingly never-ending bad-loan debacle. The latest evidence: On May 16, nearly a decade into Japan's banking crisis, Resona Group, Japan's fifth-largest banking group, with $360 billion in assets, announced that -- surprise! -- it needs an estimated $17 billion cash infusion to shore up its capital base. In the blink of an eye, Japanese Prime Minister Junichiro Koizumi offered to put up the cash, giving the government majority ownership.
That rattled the Tokyo stock market, but Japan's Financial Services Agency says relax, there's no need to worry. "We are not aware of any other banks" in serious trouble, says a senior official, in a deadpan delivery worthy of Agent Smith, The Matrix' guardian of the status quo. But the markets are just saying no to the blue-pill pushers. Japan's bank stock index has dropped 35% in the past 12 months alone. And who can blame investors for fleeing? This marks the second bailout in four years for what's now known as Resona. Its two core banks, Daiwa Bank and Asahi Bank, collected a no-strings-attached $7 billion bailout back in 1999 before they united last year in a merger of weaklings.
Worse yet, there are few signs this bailout will work. True, top management has resigned, and the bank will effectively be nationalized. But don't expect a wholesale makeover. The government seems perfectly willing to settle for half-baked restructuring.
The real mind-blower is that the senior FSA bureaucrats and Koizumi expect the world to believe them when they say the Resona bailout is a one-time affair. It isn't. It was the use of deferred tax assets to calculate core capital that sank Resona, and the same accounting device could trigger other bank bailouts. Deferred tax assets are essentially future tax refunds banks anticipate collecting once they clean up bad loans. The government figured this accounting technique, which is used even in the U.S., would encourage a financial cleanup. Auditors have allowed the uncollected refunds to be counted as part of capital even though they aren't a concrete asset. On Resona's books, these yet-to-be-earned credits represented an amazing 77% of its core capital. But the bank's auditor, Shin Nihon, reined these in, slashing Resona's capital to 2% of its assets. That pushed it below the 4% capital-adequacy ratio mandated for domestic lenders, forcing Resona's senior execs to go hat in hand to the government.
One bank down. How many more to go? Japan's global banks -- Mizuho Financial Group, UFJ Holding, and Sumitomo Mitsui Financial Group -- must maintain an 8% capital-adequacy ratio. But guess what? A big percentage of the capital base of those banks is also in deferred tax assets. In fact, if you stripped out all these paper credits from the capital bases of these banks, the ratios would plummet to 5.5%. That disturbing calculation comes courtesy of the FSA -- the same agency that says a crisis is not imminent.
If Resona is the template, then all of Japan's banks should be declaring their capital-adequacy ratios minus deferred tax assets. While the use of these assets to calculate core capital is unlikely to be banned outright, Heizo Takenaka, who runs the FSA, wants to set a cap. Of course, that could trigger another big bank bailout in the coming weeks -- precisely what Koizumi's ruling Liberal Democratic Party fears.
The day of reckoning can't be put off forever. Sure, the guys in dark suits and sunglasses pretend that's not going to happen. But truth is "like a splinter in your mind driving you mad," to quote Morpheus -- and must be faced. Bremner covers Japanese finance from Tokyo.