Losing Hope in Japan
19 September 2002
stratfor.com
Summary
The Bank of Japan soon will begin purchasing depreciated stock holdings from dysfunctional banks in an attempt to prevent the sector's collapse. Most observers agree the move is economically unwise, but they have missed the bigger point: The BOJ's governor has given up hope for saving Japan's banking sector.
Analysis
Bank of Japan Governor Masaru Hayami said Sept. 18 that he will order his institution to begin purchasing stock holdings from banks. The Nikkei, Japan's most popular stock index, registered a 2.1 percent gain on the news.
The move will undermine the effectiveness of the BOJ, the Japanese equivalent of the U.S. Federal Reserve. But more important, it signals that Hayami -- Tokyo's most important advocate for economic reform -- no longer has faith that the Japanese banking sector will recover.
Without a functional banking sector, the entire Japanese economy would not be far from collapse.
Japan's post-war economic development was heavily directed by Tokyo. Government planners urged banks to lend to strategic sectors, without regard for profits. That chopped into the banks' revenues and forced them to invest heavily in shares to help bolster their profits. The process was sustainable as long as the supported industries remained semi-viable and stock prices continued growing.
Both trends ended when the Japanese bubble burst in the early 1990s. The impact destroyed banks' profit margins and their willingness to risk capital on new loans. The institutions were placed in the awkward position of needing to continue loans to -- and buying shares from -- defunct enterprises to keep their loan portfolios from becoming entirely non-performing.
Since political leaders were unwilling to inflict the necessary pain and clean out the system, the entire banking sector rotted to the core. By some measures, Japanese banks now hold as much as $2 trillion in bad loans, and their stock holdings are worth $330 billion -- less than a quarter of their value before the bubble popped.
Hayami's solution is to have the BOJ purchase these devalued shares to boost the banks' capital holdings and reduce their concerns about the underperforming Nikkei. "The bank will buy directly from financial institutions," he said. "We want to help them reduce the impact of falling stocks."
The criticism from analysts the world over has been scathing, and rightly so. A straightforward stock purchase will do absolutely nothing to encourage better behavior, and it is highly likely that many banks will simply reinvest the new cash in the same companies they are keeping alive with drip-feed loans. And the move will weaken the BOJ's balance sheet drastically -- never a good thing for a country's financial guarantor. Critics also charge that having a country's central bank reduce itself to base stock market manipulation is not only unwise but also a disturbing sign that Japan's central bank has lost its independence. A central bank without freedom reflects dominant political trends and loses the ability to shepherd an economy to health.
The critics are right on the first point, but wrong on the second. Most government policy makers want an outright stock bailout. Hayami doesn't: His actions achieve a bailout, but as a side-effect of efforts to assist the banks -- and that's an important distinction.
However, a look at Hayami's motivations signal that something much worse than merely caving to administration pressure is occurring.
The Japanese fiscal half-year ends Sept. 30. On that day, Japanese banks will close their books and check their valuations. With the Nikkei edging 20-year lows, many banks are in danger of dipping below capital adequacy minimums. If that happens, most would be unable to engage in domestic lending -- many already are barred from foreign lending because international banking laws are stronger than those in Japan. Hayami's move has little to do with Tokyo's efforts to produce a veneer of progress; it is designed to avoid a banking collapse.
When viewed in this light, it becomes apparent that Hayami has lost faith in the Japanese system's ability to salvage itself. He fully understands the implications of his actions and the damage they will cause the BOJ, but he has come to realize that the rot in Japan's financial sector is now irreparable. All the BOJ governor can do now is to try and slow the steepening decline. |
