Why Failures Make Sense

They can lead to the creation of a sounder Asian economy

Haruo Hanazawa thought he had seen it all. At 63, he has lived through Japan's postwar ravages, its meteoric rebound, the heady late-'80s "bubble" era, and this decade's prolonged market meltdown. But who would have thought it would come to this? Yamaichi Securities Co., a behemoth broker with $188 billion in investments under its care, went bust on Nov. 24, the biggest bankruptcy ever in Japan.

So at 9 a.m. sharp the very next day, Hanazawa waded through the throng of company guards and television crews parked in front of Yamaichi's global headquarters in Tokyo to get his money out. As it happened, he was one of a legion of frantic investors from Osaka to Sapporo that mobbed the brokers' local branches with the same aim. "Banks and securities companies are now in a dangerous situation," says the retiree. "I'm just going to put my money in my desk for a while."

Japanese banks and brokerage houses fail. Financial rescue squads from the International Monetary Fund scurry across the region. Korea is on its knees. President Clinton implores the Asians to fix their problems before they trigger a global recession. Japanese Prime Minister Ryutaro Hashimoto concedes that Japan's leaders taxed their country into a recession. Bourses in Jakarta, Kuala Lumpur, and Bangkok seem to have no bottom.

Nobody ever said failure was fun. But now, Asia's economies, policymakers, and workers are learning its bitter lessons. Their response: Many are denying the gravity of the situation or are threatening to block any moves toward austerity and serious reform. In Japan, regulators ignore or soft-pedal the mounting evidence of major insolvencies in the financial sector. In Korea, the unions promise the mother of all strikes if IMF-imposed measures force major layoffs. At the Vancouver meeting of the Asia-Pacific Economic Cooperation forum, Malaysian Prime Minister Mahathir Mohamad attacks free-market advocates for effectively asking bailout recipients to "surrender [their] independence" while they ignore the fact that "market forces are as prone to abuses as command economies."

Anger, denial, shock: They are all to be expected. Some will remember that America, too, went through a painful self-searching in the 1980s, as a banking industry blowout and a major industrial restructuring jolted the economy. But if these emotions translate into a do-nothing attitude toward the crisis, Asia's governments will be missing a rare opportunity. For the failures point the way to the creation of a much sounder regional economy that could propel global growth well into the next century. But before the failures can pay off, authorities have to allow even more institutions to fail or merge, sever the link between politics and corporations, and even accept foreign ownership of major banks and companies. Governments will have to create jobless benefits for the newly unemployed. The swifter Asia's policymakers embrace these painful necessities, the faster the crisis will pass.

For any of this to happen, it's essential that Japan, the region's economic leader, show the way. The Tiger economies of East Asia have long borrowed from Japan's brand of centrally controlled capitalism, which promoted the accumulation of savings, relied on technocrats to allocate capital into pet industrial projects, and permitted close relations between ruling parties and favored corporations and banks. So if Japan starts dismantling its system, its neighbors to the south may well follow.

Fortunately, after years of denial and feinting left and right, Japanese officialdom may finally get serious about overhauling its overcrowded, inefficient, and corrupt financial sector. That's because the failures are now just too big to ignore. It's as if a giant trap door has materialized under the nation's weakest banks and brokers. During the past month, both Sanyo Securities Co. and Hokkaido Takushoku Bank Ltd., a major lender, have collapsed. Some economists think one-third of all Japanese institutions will eventually fail or be merged out of existence. "Five years from now, we will see quite a different financial landscape," figures Toyoo Gyohten, a senior adviser to Tokyo-Mitsubishi Bank and former Vice-Minister for International Finance.

If this situation is not addressed correctly, Japan's financial institutions face slow strangulation. The risk premium Japanese banks must pay to attract short-term, interbank funds to finance their loans is getting prohibitive, since international lenders see the whole Japa-nese sector as high-risk. Japan's weaker banks are now paying up to 75 basis points above prevailing international rates--but can only lend out at lower rates to local customers. Says Robert Brusca, Nikko Securities Co. International economist: "This is very dangerous. The Japanese banks are being ground up like lunch meat by the markets."

SILVER LINING. Yet there's opportunity in the danger. The Ministry of Finance, for example, has long deferred an inevitable restructuring by forcing strong banks to help weak players. Now the markets are blocking the MOF's attempts to keep the system intact. Sanyo's fate was sealed when life insurers refused to roll over $166 million in loans, and the MOF couldn't persuade Bank of Tokyo-Mitsubishi and Nomura Securities Co. to step forward. When Yamaichi disclosed to Fuji Bank Ltd., a big creditor and its biggest shareholder, that it had billions of dollars in hidden losses, Fuji cut it off at the knees.

One U.S.-based analyst who follows Japan thinks six more banks could go under from the strain. On Nov. 25, Standard & Poor's Corp. cut its long-term debt rating on Yasuda Trust & Banking Co. to junk-bond status, noting its historical ties to Yamaichi and the "very severe operating environment in Japan." A bank spokesman said he "can't accept" the ratings downgrade, noting that Yasuda has procured enough foreign funds to carry it through yearend and is selling Tokyo headquarters to raise cash.

Japan now has a chance to use its deep reserves to protect depositors, while letting more banks, brokers, and insurance companies disappear. Perhaps as much as $80 billion will soon be committed by the Hashimoto government to avert a liquidity crisis and beef up Japan's woefully underfunded deposit insurance scheme. Japan's $2 trillion postal savings system may also be tapped to expand the Deposit Insurance Corp. A stronger DIC could prevent a full-blown deposit run and might be given expanded powers and independent examiners to identify banking basket cases earlier. Such a move, coupled with a round of income tax cuts, could be announced by the government in early December. If so, Japan might finally turn the corner.

LESSONS. If Japan accepts the need for more pain, Korea may find it easier to follow. In exchange for $20 billion in emergency funding to the Seoul government, the IMF is likely to demand financial closures, higher taxes, fiscal restraint, and tougher regulations to prevent the nation's industrial combines, or chaebol, from expanding into new fields. The IMF has already asked the Seoul government to hand over the books of the country's banks and merchant banks. The IMF delegation is dividing into teams to focus initially on five sectors--the larger economy, fiscal policies, the balance of payments, the money supply, and the currency. "Koreans are finally learning that there's no free lunch," says Kim Joon Kyong, an economist at the Korea Development Institute.

The other Asian countries have to learn the same lesson. In Thailand, the recent election of Prime Minister Chuan Leekpai has restored a measure of calm for the moment. Even the currency has stabilized somewhat. But the toughest moves are yet to be made. Chief among them is whether to shut down 58 suspended finance companies that made big and ill-fated bets on Bangkok's slumping property market. The government will decide the finance companies' fate by Dec. 7.

And with the Thai economy expected to grow less than 1% over the next year--far lower than the IMF's initial projections--Chuan will need to push through more spending cuts. For the moment, street protests in Bangkok have subsided, but that could change if the IMF's austerity plan starts to exact more pain. "Even if they get the support from the people, there is a tough job ahead," says one senior Thai economist.

For these fiercely proud societies, the new reality of failure is deeply unsettling. Yamaichi President Shohei Nozawa was reduced to tears as he announced the collapse of his company. In South Korea, there was talk of the "national humiliation" of requesting IMF intervention. Yet if the Pacific Rim economies ever hope to regain their vibrant image as the ascendant force of the next century, they will need to embrace the idea that no lender, broker, or corporate chieftain is too big, or too politically connected, to go under. Asia will feel more pain before it can prosper once more.

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