And Now For The Really Bad News...by
After four years of economic stagnation, Japan is on the brink of recession. Government rescue packages trundled out since 1993 haven't done the trick. Indeed, five years after the collapse of the bubble economy, share and land prices--the foundation of Japan's national wealth--are continuing to skid.
But look at government accounts or a corporate balance sheet, and you'll find scant evidence of this decline. Share prices, even after the 62% tumble of the Nikkei stock average since 1989, are still considered to be ridiculously high. Accounting gimmickry cloaks a huge hole in Japan's $595 billion corporate pension system. Other maneuvers allow the government to understate its debts by 6%. And with property prices still falling, the collateral banks are holding on an estimated $1 trillion in bad loans is probably worth nowhere near its value on lenders' books.
So what is Japan Inc. really worth? No one knows for sure--but it's a heck of a lot less than what it appears to be. According to a BUSINESS WEEK analysis of probable further declines in the property and stock markets, trouble with corporate pension funds, an understated budget deficit, and losses on foreign holdings, Japan's assets could be overvalued by a head-spinning $7.7 trillion.
To be sure, with more than $20 trillion in financial assets at home, including huge troves of corporate cash, and world-class fixed assets overseas, Japan has vast resources at its disposal. The trade deal with the U.S. on autos could give markets and the economy a boost by weakening the yen and shoring up profits. Nevertheless, the potential loss of even more national wealth in the post-bubble economy has frightening implications. Efforts to stimulate economic growth are unlikely to bear fruit if Japanese consumers and companies see their assets' value continue to dwindle.
Tokyo is trying anyway. Following word that Japan's economy grew at an alarming 0.3% annual rate in the first quarter, Prime Minister Tomiichi Murayama's fragile coalition on June 27 announced its third emergency spending package since April. In explaining the plan, Finance Minister Masayoshi Takemura conceded that Japan's fears of recession and bank failures have "come to the notice of the entire world."
NO CHOICE. It's not hard to understand why. If Japanese life insurers and banks are forced to sell their vast bond holdings to raise cash, they could cause a global cascade effect by depressing prices and pushing up rates. Japanese investors dumped $35 billion worth of U.S. Treasury bonds alone in 1994.
The Japanese probably have no choice. Domestic commercial property prices have fallen at least 50% since 1991, vaporizing $15 trillion in national wealth--roughly three times Japan's annual economic output, figures Bernard Siman, a real estate analyst with UBS Securities Ltd. in Tokyo. No wonder jittery Japanese companies unloaded $6.6 billion worth of real estate last year. E&Y Kenneth Leventhal Real Estate Group estimates that an additional $10 billion worth could follow this year.
It's true that properties picked up in the 1950s are way undervalued, even at today's prices. But since Japanese banks, life insurers, and corporations carry land holdings at their acquisition cost rather than at current values, it's tough to gauge their true exposure in today's market. "I don't think there is an accurate valuation of prices here," says Richard Mandel, a real estate broker in Tokyo with U.S.-based Kennedy Wilson International.
There are some clues, however. Take Credit Cooperative Purchasing Co. (CCPC), a vehicle set up in 1993 by 160 Japanese banks and insurers to buy up bad loans. Their idea was to get foreclosed property off their books by transferring the rights to CCPC. Lenders get a tax break if the loans are written down. But unless the banks and insurers can find a third-party buyer for the CCPC-held property, they will eventually have to take it back.
So the CCPC experiment has proved to be a Band-Aid. The company has assumed more than $100 billion in loans backed by property, at 55% of their original face value. But it has been able to resell only 2% of the loans. Siman reckons land prices will have to fall 20% further before CCPC can unload all that sour collateral. Even cheaper property values may not do the trick. "Nobody has the money to buy," says Lynn Pickard, a real estate attorney with Hideki Kojima, a Tokyo-based law firm.
Things hardly look better at the Tmkyo Stock Exchange, where prices have tumbled 25% this year. That's on top of a decline of nearly $2 trillion in market capitalization for blue-chip stocks since the peak in 1989. With shares still fetching an average price-earnings ratio of 50 times estimated earnings for the fiscal year ending March, 1996, the Nikkei will have to shed 14% more before it's fairly valued, figures David Pike, an equity strategist for Barclays de Zoete Wedd. "Even [with the index around 12,000] we couldn't say stocks are unequivocally cheap," says Pike. "I'm worried the Nikkei will even go lower."
That would be bad news indeed. Thanks to Japan's system of interlocking shareholdings, banks and insurance companies own 25% to 30% of outstanding shares. These cross-shareholdings represent a hefty portion of the banks' and insurers' capital. As bad debts have mounted, banks have sold shares to cover write-downs. Banks have also sold shares bought decades ago, then immediately bought them back at today's prices, to strengthen their balance sheets. And life insurers, which issued policies promising a 4.5% return in the late 1980s, have also been dipping into their portfolios to make up the difference between that and the 2.5% return they're now getting on their investments. Yet if the Nikkei index falls much below 12,000, these hidden reserves could be wiped out.
FILL THE GAP. Falling asset prices are also putting pressure on pension plans. On paper, Japan has $595 billion in corporate pension assets. But they are valued at their acquisition cost. If stock holdings and land holdings were marked to market, plans would be underfunded by as much as 30%, says Yoshio Takizawa, managing director of Moody's Japan. Add to that Japan's aging salaried workforce, and you have a crisis brewing. It would be up to companies and employees to fill the $178 billion gap--unless Tokyo steps in.
The federal debt load would make that tough. On paper, the budget deficit is a modest 2% of gross domestic product. It's closer to 8% if you throw in off-budget borrowing for public works and exclude the $100 billion in annual social-security contributions from taxpayers needed to keep Japan's pension system solvent. Those contributions are now recorded as government revenues--even though they can't be used for public spending. Lehman Brothers Inc. economist Andrew Shipley expects Japan's outstanding government debt-to-GDP ratio to hit 82.6% this year, vs. 64% in the U.S.
Japan, of course, isn't the only country that plays games with its accounting. But the $7.7 trillion difference between reality and what's on the books has to be addressed before confidence is restored. Policymakers may keep flinging new spending packages into the system. If the national wealth keeps draining, however, those drops may do little to fill the bucket.