Ref. yours ....Marty Whitman is made of sterner stuff. You may remember that back in mid-June I had spoken to the veteran distressed securities investor about his investment in the Long Term Credit Bank of Japan. At the time, his funds' average cost in LTCB was around 140 yen. On Friday the bank's shares closed at 54 yen. That is pain.
When I called him back this week, Marty said he wanted to put off any comments on LTCB until next week, when I guess the fate of the current version of the Japanese government's rescue plan for the bank will become clearer.
He did, however have something to say about how the workout process is proceeding in Japan.
It isn't.
"I was at a conference (on the Japanese bad-debt problem) in July, with senior Japanese officials and the American officials who are giving them advice. Neither side knew what it was doing, but the Americans were more arrogant", he said.
And now to the meat of my cherry morning post. Please note that apparently the Long Term Credit Bank holds, as of March last, approximately $750 billion dollars of derivatives. Please reflect upon this. In case you all need a sense of scale... that is approximately twice the last super power's military budget per annum.
This is one Japanese bank. What are our banks holding in terms of derrivative contracts?
For Private Use Only
Sick banks set the next domino teetering
Date: 29/08/98
By RUSSELL SKELTON, Herald Correspondent in Japan
AFTER months of unfathomable complacency about the sinking swamp that has become Japan's economy, signs of panic are beginning to emerge in the ranks of the ruling Liberal Democratic Party.
This week, Japan's new Prime Minister, Mr Keizo Obuchi, a leader not known for extravagant statements of any kind, and his elderly Finance Minister, Mr Kiichi Miyazawa, appeared to be losing their nerve as their push to reform the world's second-largest economy stalled in the Diet.
For the first time since assuming office last month, both men openly warned that Japan's banking crisis could trigger global financial disaster. Admittedly, their dire predictions came in the middle of an intense domestic political debate over plans to merge the failed Long Term Credit Bank of Japan (LTCB) with the Sumitomo Trust, but few analysts doubt their accuracy.
Japan's banking crisis is crippling the economy and the Government appears to be no closer to solving it than it was eight months ago when the yen currency plunged, leading to a blowout in bank debts.
With bad loans totalling a stupendous 77 trillion yen ($927 billion) - although the real figure may be closer to 100 trillion - the banking system is close to collapse. And with Opposition MPs delaying in the Diet urgently needed economic reform bills, the situation is grave.
Japan's economy is caught in a recessionary trap. To cope with mounting debts, banks have imposed a vicious credit squeeze on borrowers while refusing to extend any new loans to even healthy businesses.
As companies fold by the hundreds each week, pushing up the number of unemployed, domestic markets are shrinking, making it increasingly harder for viable companies to maintain profits. Sales of cars, houses and retail goods are tumbling. Worse still, prices are also beginning to fall.
As Mr Richard Koo, the chief economist of the Nomura Research Institute, puts it, Japan does not have a problem with problem banks, but a systemic banking crisis.
"A systemic banking crisis happens when all banks have capital problems, when all banks cannot move ... when all banks cannot extend their lending," he said.
Mr Koo is a highly respected American-trained economist who worked for the US Federal Reserve bank during the Mexican bailout. He was recently named the top economist tracking Japan.
Mr Koo is scathing about US criticism of Japan and simplistic market solutions for solving the bank bad-loan problem which call for the closure of bad banks so the healthy can survive. As there are no healthy banks in Japan, he argues that would lead to disaster and depression.
MR KOO notes that even the nation's biggest bank, the Tokyo Mitsubishi Bank, has a capital/asset ratio of less than 8 per cent capital - the internationally acceptable level. Other analysts maintain that only five of the nation's top 20 banks could be regarded as being solvent.
"If the Tokyo Mitsubishi Bank, the best bank, is less than 8 per cent, you can imagine what the rest are like," Mr Koo adds, arguing the Government has no choice but to save all banks as the United States did back in 1991 when its banks were in trouble and the economy hit the worst recession in 50 years. Anything less than a total bailout using public funds will not work, he says.
To start closing banks would be suicidal for the economy. Mr Koo predicts that problem loans would increase, unemployment already at a post-war high would skyrocket and banks that were halfway viable would "go down the drain as well". All this would drag the global economy down because Japan's banks are big overseas lenders, particularly in Asia, which is already in crisis.
After Russia, Japan is the weakest link in the global economy. With its financial system in crisis and the economy in its worst recession in 50 years, with no immediate prospects of growth, Japan is in no position to be an engine for global economic growth or a saviour for Asian economies.
Japan has been reliant on Asian markets for its growth. Just two years ago, more than 40 per cent of Japan's exports went to Asia, compared with only 18 per cent to the US. But this year, Japan's exports to Asia have almost halved.
The immediate focus for concern in Japan is the proposed merger of the LTCB, which has debts of 2.8 trillion yen, with the Sumitomo Trust. The Government, like Mr Koo, believes that the bank must not be shut down because that may trigger a string of other corporate and banking collapses. Opposition MPs, infuriated by cover-ups of scandalous management practices at the bank, and apparently oblivious to dangers posed by stalling the merger, are delaying passage of the Government's economic reform bills.
Mr Miyazawa underlined the gravity of the crisis when he answered questions on the merger in the Diet on Thursday. He said that if the LTCB were allowed to collapse, damage to the economy would be incalculable because the bank had 50 trillion yen worth of derivatives contracts at the end of March.
"If the bank defaults on its derivatives transactions, Japanese banks as a whole might be barred from such transactions," he said.
But the Governor of the Bank of Japan, Mr Masaru Hayami, went even further. If any of Japan's large banks with huge outstanding derivatives contracts failed, he said it would trigger a chain reaction of credit disorder on global financial markets.
But it is not just the politicians and the bureaucrats who are beginning to sweat in public; investors are showing signs of fear. Tokyo stocks fell to a six-year low this week as concern over the banking crisis mounted and worries about the health of global share markets spread.
AS Mr Gary Evans, a strategist with HSBC Securities (Japan), observed: "It's a blood- bath out there ... there is a fear that there could be a major sell-off in the US and one of the largest economies in the world, Russia, said it will default on its debt."
He could have added that official figures released showed that Malaysia's economy is shrinking by 7 per cent and South Korea's by 6.6 per cent, which puts those countries one step closer to a depression.
Mr Koo believes Japan must work to strengthen the yen and use public funds to bail out all banks. A further collapse in the yen would also be disastrous because Japanese banks hold one trillion dollars in assets overseas. He estimates that a depreciation of 1 yen against the US dollar is equal to a 3-trillion-yen credit crunch for Japan's domestic borrowers.
He says Japan cannot follow the US model used by Federal Reserve chairman Mr Alan Greenspan to solve the 1991 US credit squeeze.
"Greenspan allowed US bankers to keep the prime rate at 6 per cent while the Federal reserve on Federal funds was lowered all the way down to 3 per cent to give the US banks a full 300 basis points of profit to recapitalise themselves," Mr Koo said.
"The Greenspan solution was 300 basis points to all banks, good and bad, big and small. Because he had a systematic banking crisis, he had no choice."
Mr Koo says such options are not available in Japan because interest rates are down to 0.5 per cent and the short-term price is 1.6 per cent. If you want to give 300 basis points to Japanese banks, you have to have negative interest rates and that is not possible.
He says that the Obuchi Government must borrow ideas from President Roosevelt, who steered the US out of the Great Depression by finding a way of injecting capital into the banks without undermining them at the same time. The problem in Japan lies in persuading banks to accept funds from the Government - some 30 trillion yen has already been set aside - as they rightly fear that as soon as they do, rating agencies will swoop and downgrade them, and investors will dump shares.
But just how this can be done is far from clear and the Government is yet to fully focus on the problem, preoccupied as it is with Opposition antics and blustering in the Diet which has become an extraordinary sideshow, distracting attention from the ominous cracks that keep appearing in the economy. If at last the Government is beginning to panic, there are no signs that either the Opposition or Japan's media, which oppose public bailouts as an article of faith, understand the gravity of the crisis.
Japan is not only the next weak link in the world economy. It is one that seems destined to go left unattended while its politicians squabble among themselves over the use of taxpayers funds to avert a crisis that threatens global markets and the world economy.
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