Japan Needs More Than A Bailout

Japan's financial sector is a basket case. The Nikkei has plummeted 62% from its airy 1989 high, while prices of commercial property have tumbled more than 50%. There have been runs on credit co-ops, and housing loan corporations are virtually insolvent. The upshot: Japan's financial lenders, from commercial banks to agricultural banks, have nearly $1 trillion in bad loans on their books--about 20% of the country's annual economic output. Even at the height of the savings and loan crisis in the U.S., sour loans never amounted to more than 9% of America's gross national product. The Japanese economy, and with it the global trading system, is skating on very thin financial ice.

Wrongheaded bureaucrats, shortsighted central bankers, and weak politicians are to blame. For nearly five years, the mandarins at Japan's Ministry of Finance actively collaborated with the banks in cloaking the magnitude of the crisis. MOF bureaucrats allowed banks to hide their tattered balance sheets and juiced up the stock market with public money to give banks time to clean up their act. It didn't work. Markets never got a chance to clear at lower prices, and government manipulation prolonged the financial and economic pain.

Japanese politicians are no better. A divided conservative-socialist government is unable to lead. Worse, politicians of all parties have received huge campaign contributions from the financial sector. The only time the politicians and MOF tried to organize a bailout was to help two corrupt Tokyo credit cooperatives with political ties. The ensuing scandal eroded public support for bailing out the banks.

But that is precisely what must be done. An expensive and massive makeover of the banking system is inevitable. The recent emergency bailout plan is timid fare. What's needed next is an honest accounting of how bad the banking crisis truly is, a mark-to-market of bad loans, and a hard-nosed assessment of how much the public will have to shell out to clean up the mess. Lower interest rates will be needed to finance the restructuring of the banking system.

Time is running out. Deflation is killing off growth and jobs in Japan. Gold prices in yen are falling, real interest rates are rising, and the yen is grossly overvalued. MOF bureaucrats are on a financial suicide run, battling inflationary demons that do not exist while hiding banking problems that really do. This is a scenario that has disaster written all over it.

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