View From Tokyo: A beautiful way out of a crisis

THERE is no longer any dispute in Tokyo about the single most important problem facing the entire Japanese economy: the health of the financial system. When Japan's Finance Minister, Tsutomu Hata, said last month that financial institutions were facing their 'most severe conditions since the war', his words carried considerable weight. No Japanese bank has been allowed to fail since the war, and until recently the Ministry of Finance (MoF) regarded this almost as an article of faith.

The fact that this unthinkable prospect is now being openly discussed is evidence that even the smart boys in the MoF admit that the financial system is in a state of crisis, brought on by a mountain of bad loans that were doled out freely in the years of the bubble economy.

However, the ideograms for crisis in Japanese are similar to those for opportunity, and despite widespread scepticism that the government has even now got a real handle on Japan's financial woes, some analysts see the makings of a masterful rescue of the country's banks. This, they believe, would simultaneously achieve the long sought- after rationalisation and streamlining of Japan's prehistoric financial system.

Sinking collateral

The heart of the matter is the estimated Y200,000bn ( pounds 800bn) that the banks have lent using property as collateral. With many of these loans now paying no interest - estimates vary from the government's figure of Y8,000bn to private economists' estimates of anything from Y20,000bn to Y40,000bn - and with the underlying value of the property collateral sinking, many banks find themselves in the deeper recesses of the proverbial creek, with no paddles and precious few life-jackets.

Mr Hata came out with the idea last month of setting up some form of organisation that would purchase this property that was no longer worth its weight as collateral. Neither he nor Yasushi Mieno, the governor of the Bank of Japan, has said anything about committing public funds to this organisation, but the stock market has already bid up banking shares. In the past three weeks investors have pushed up the market capitalisation of the city banks alone by more than 25 per cent.

Economists were incredulous. If no public funds were to be committed, there could be little sense in the banks financing the scheme on their own: buying up your bad debts will not make them disappear. But if the government was going to put up public money, how could it sell this to taxpayers, when the final bill could amount to many thousands of billions of yen?

One possible explanation, suggests Walter Altherr, the banking analyst for WI Carr in Tokyo, is that the MoF is thinking much further ahead than many economists give it credit for. The scenario painted by Mr Altherr is one of a delicate finesse, where the ministry will quietly manipulate the land repurchasing organisation from behind the scenes. It will avoid a general financial meltdown, while at the same time pushing the weakest banks into marriages with stronger institutions.

'There is a lot of public posturing going on, but so far there has been no pledge of public funds,' Mr Altherr says. 'First, this is probably because of the potential public outcry. There is also the question of how severe the problem is. But mainly it is an issue of control. The MoF wants to change the financial sector, but it doesn't want to commit money first, because that would lessen their leverage.'

In theory, the land repurchasing organisation is supposed to be established by Christmas. So far, the main investors are supposed to be the banks. What happens after that is still guesswork. But according to Mr Altherr's scenario, the MoF is already working from a pre-written script. The initial capital of the organisation would be quite small, possibly several thousand billion yen from the banks, which would be matched by the MoF, drawing on low-interest loans from the Bank of Japan.

But the MoF would be waiting in the wings for a big bankruptcy, or imminent bankruptcy, to step in and argue that more public funds were needed to safeguard investors and maintain the viability of the financial system. Faced with a concrete crisis, public reaction would probably be muted.

The MoF, still operating from behind the screen of the land-repurchasing organisation, would then be in a position to bargain some public funds for the most troubled banks in exchange for a friendly takeover from a healthier institution. It is a classically beautiful Japanese manoeuvre, performed behind the scenes using a convenient intermediary that the MoF itself suggested in the first place.

Other kinds of manoeuvre would be possible. One widely talked-about mechanism would be the issue of mortgage-backed securities, which could mitigate some of the value fluctuations of the property.

On the face of it, the repurchasing organisation would be a private one, but observers believe that, as more government funds were committed, there would be more MoF involvement - possibly from former officials who have now 'descended from heaven' into private sector jobs.

Chaos avoided

It is a beautiful idea - if it works. The financial sector, with its absurd number of city and regional banks, trust banks, credit co-operatives and non-bank banks, would get its overdue shake-out. Chaos in the financial world would be avoided, and the taxpayer, although paying the bills, will hardly be in a position to complain.

There are, of course, plenty of pitfalls. The biggest is within the economic bureaucracy itself. To cover all the troubled lending institutions will require co-operation from the Ministry of International Trade and Industry, which supervises the non- banks; the Agriculture, Fisheries and Forestry Ministry, which runs its own co-operatives; and the Posts and Telecommunications Ministry, which presides over the huge pool of postal savings.

At the same time, the banks' recent share-price gains are unlikely to hold up: all are going to face depressed earnings for the foreseeable future, and even if large amounts of public funds are made available, they will only go to the most troubled institutions, which no right-minded investor would want to own in the first place.

Of course, the bad debts may prove too big even for the MoF to handle, crashing down on the market like a tidal wave. But Mr Altherr, for one, is more optimistic. Comparing the scheme to the Resolution Trust Corporation which bailed out the savings and loans mess in the US at a cost of dollars 200bn, Mr Altherr says Japan may be able to avoid some of the pain experienced on the other side of the Pacific. 'The MoF wants to operate an emergency room, not a mortuary.' (Photograph omitted)