Japan's alarm bells toll on deaf ears
Fears rise as banking system could collapse like a house of cards
By: Jacqueline Thorpe
Financial Post
February 21, 2002
Take Enron, multiply its off-balance-sheet debt by a trillion and what do you get? Japan. That's the joke making the rounds these days about the world's most dysfunctional economy.
"There are myriad problems with the banks, many of them covered up by impenetrable accounting conventions and an army of managers, regulators, auditors and credit raters who have been happy to look the other way for decades," said chief economist Carl Weinberg of High Frequency Economics in a recent report. "How else can a banking system run up a bad-debt book of 200-trillion yen -- US$1.5-trillion -- without triggering alarms."
With the threat of a major credit downgrade hanging over it, the fiscal year-end drawing close and the stock market stumbling, the alarms are once again going off full blast. There's concern that after a decade of denial and dallying over structural reforms, Japan's banking system is about to collapse in spectacular Enron-like fashion.
But the more likely scenario is that the status quo will be maintained, with the economy growing just enough to stave off a crisis but nowhere near the growth the country is capable of.
The latest alarms were tripped last week by Moody's Investors Service when it put Japan's sovereign debt rating on review for a possible two-notch downgrade. As newspapers cheekily pointed out, such a downgrade (and putting a country under review virtually guarantees one) would put the rating of the world's second-largest economy on par with Botswana -- and five notches below that of the United States, Britain, France and Germany.
Meanwhile, the corporate fiscal year-end is March 31, at which time banks will be obliged to write down the value of the equity portfolios acquired in the 1980s boom to today's market prices. And with the Nikkei stumbling well below 10,000, equity losses will be massive.
To Mr. Weinberg's mind, the triple whammy will be enough to push Japan's creaking banking system over the edge and quite possibly create the kind of nightmarish international banking crisis that keeps the world's central bankers up at night.
This is Mr. Weinberg's view of what could happen: Moody's cuts Japan's sovereign rating, triggering downgrades on the banks. That makes it impossible for the banks to do business in the world's capital markets. This in turn creates a cascading failure to settle transactions, similar to the situation in September, 1998, that bankrupted U.S. hedge fund Long Term Credit Management and saw the Federal Reserve Board ride to the market's rescue.
At the same time, new rules drastically reducing deposit insurance set to take effect in April might also spur a rush to withdraw funds, creating an old-fashioned run on the banks.
"Moody's can pull the plug by downgrading the banks to a point where they can't function any more and therefore they become effectively bankrupt in the international community," said Mr. Weinberg. "That's what's different now and what's different on the Moody's side is that since Enron, the people who do things like due diligence and auditing have a lot more heat applied to them."
That may be true, but Japan has shown itself to be skilled at averting economic catastrophe. The government just prints more money. Only yesterday news wires reported rumours the Bank of Japan had asked the government to consider another capital injection for the banks. If the government goes ahead it would be the third injection of public funds in the past four years.
Similarly, the equity portfolio adjustments could be glossed over. Analysts had expected a banking crash when the rules were introduced last year, but when half-year results were due on Sept. 30, the banks simply avoided reporting full statements. The authorities turned a blind eye.
A similar manoeuvre may not be so easy to pull off at the full-year mark on March 31, with international credit agencies breathing down their necks. At the same time, any new debt issuance to pay for the capital injection could in itself trigger a sovereign debt downgrade as more pressure is put on Japan's already sky-high 130% debt-to-GDP ratio. Bond yields could also rise -- and higher interest rates are exactly what the Japanese economy does not need right now.
However, other analysts say the Japanese authorities have any number of manoeuvres that could make it possible for the banking system and the economy to continue to muddle along. Options could include bumping back up deposit insurance coverage, changing the mark-to-market rules or introducing special accounting rules for bad loans.
"They have been able get around these deadlines time and time again because they know how to twist the details and get through the loopholes," said Robert Fairholm, managing editor of International Bank Credit Analyst in Montreal. "It's constant seat-of-the-pants crisis management but no long-term solutions."
Even Mr. Weinberg admits: "They have an incredible capacity to pull it out of a hat."
Some economists say it will likely be a U.S.-led global economic recovery that will save Japan in the short-term, just as it was when the banks were up against the wall after the Asian crisis in 1999.
"I think they will be able to defer the issue on the back of a global upturn," says Andrew Snowball, portfolio manager at Julius Baer Investment Management in London.
A weaker yen could rekindle the export sector, stoking business activity and consumer sentiment and finally putting a stop to the deflationary price spiral that has gripped the country.
Perhaps the biggest argument against a wipe-the-slate-clean catastrophic resolution to Japan's economic mess -- assuming banks can get past March 31 without touching off a world banking debacle -- is that there simply isn't the kind of international pressure that has undone countries like Argentina.
Japan's staggering public debt is virtually all owned by Japanese nationals while its credit with the rest of the world is unparalleled. The economic expansion that made the country the envy of the world in the 1980s stuffed Japanese coffers to the brim.
There is an estimated 1,386-trillion yen (US$10.4-trillion) in private savings stashed away, which Japan could comfortably live off for years, analysts say. Current account figures last week showed Japan earned more from offshore investments and overseas subsidiaries in 2001 than from conventional trade, causing its income surplus to exceed its trade surplus for the first time on record.
"The accumulated wealth of this country is truly staggering," said Allan Seychuk, international economist at Royal Bank of Canada. "And you don't have this external debt situation that does end up sinking a lot of emerging market countries that do have to send payments abroad."
With this huge buffer of international assets, structural reform appears a long way off. True structural reform would entail getting rid of the banks' bad loans, perhaps by having the government buy them up and sell them off and allowing those that can't be cleaned up to go bankrupt.
This would unclog the arteries through which the Bank of Japan has valiantly been trying to pump liquidity, giving the corporate sector access to credit once again. It would also entail reducing regulation and opening the economy to international competition, a sure-fire way of ridding the country of the massive overcapacity hanging on from the 1980s -- and the root of Japan's problems after all.
Japan will have to tackle its problems one day. Its population is rapidly aging and that means the personal savings will be spent and the country will be unable to fund the fiscal deficit forever. |
