Last Chance For The Yen?

The "Total Plan" is supposed to fix Japan's bank mess--but time is short

Emerging out of the smoke-filled chambers at the ruling Liberal Democratic Party headquarters in Tokyo is something called the "Total Plan." Billed as the definitive solution to the banking mess that has been festering for a decade, the program amounts to a gigantic IOU from Japan to the rest of the world--a promissory note that commits the nation to fixing its banks before a sinking yen snuffs out hopes for a timely economic recovery in Asia. Days after a historic U.S.-Japan yen intervention, Group of Eight and Asian financial authorities won assurances from Tokyo on June 20 that a detailed blueprint of the plan would soon materialize.

If it isn't credible--and the yen is already giving up some of its rebound as doubts arise--global traders will turn on the yen and the Nikkei stock index with new rage. Even another U.S.-Japan currency intervention might not do much to prevent another round of currency jitters and market upheavals. That could send a tsunami of capital rushing out of Japan, making the banking mess even worse.

So it's crunch time for Prime Minister Ryutaro Hashimoto and the LDP. They have just a couple of weeks to come up with a plan that can work--and show that they mean to carry it out. They face a situation far more complex and dangerous than the U.S. savings and loan crisis, which took six years and $125 billion in taxpayer money and resulted in the closure of nearly 750 thrifts. Because Japanese officials kept postponing the day of reckoning, banks are sitting on $530 billion worth of dud loans. "Many of the top executives at Japanese banks feel a sense of crisis," says one at Sumitomo Trust & Banking Co. "We have very little time."

To say the least. Even after write-offs worth some $230 billion over the past five years, few of Japan's top 19 banks are safe from the type of sudden collapse that is the stuff of central bankers' nightmares. The banks' books are still choked with bad property loans after a decade-long bust that has knocked 70% off the value of commercial real estate. But with Japan's archaic laws on settling property claims, the banks haven't been able sell off much underlying collateral. So they can't recoup any of the money they lent and sweep the bad loans off their books.

MORE DUD LOANS. As Japan's recession spreads and corporate bankruptcies rise at double-digit rates, more problem loans will appear. Worse, there's the prospect that up to a third of the $97 billion extended by Japanese banks to the five crisis-ridden Tiger economies in East Asia could become permanently uncollectible as well. U.S. and European banks have pretty much written off suspect loans to those nations, but Japanese bankers have barely begun.

It gets worse yet. Following the collapse of Yamaichi Securities Co. and commercial lender Hokkaido Takushoku Bank Ltd., ordinary Japanese have pulled their yen out of weaker banks. Their money is going into the postal savings system controlled by the government--or heading overseas in search of higher returns. That's eroding the deposit base of weaker banks.

Meanwhile, some banks are facing higher capital costs. That may seem strange, given the near-zero interest rates put in place by the Bank of Japan since late 1995. Yet banks also rely on other global banks and investors to raise capital. And thanks to a wave of credit downgrades, suspect lenders are paying a premium to raise money at home and abroad.

Little wonder that all sorts of grim rumors are flying in Tokyo. The latest: An imminent cash squeeze at Long-Term Credit Bank of Japan Ltd. It's a titan with $190 billion in assets that was a primary conduit of government-directed lending to industrial Japan after the war but jumped into real estate lending during the bubble era. Now, LTCB has $9.4 billion in bad debts. And investors have dumped its shares, fearing that it can't roll over some $87 billion worth of unsecured bonds.

With bad news mounting daily, Hashimoto wants to call a special "bad bank" session of the Diet to push through a legislative package to bring the banking crisis to an end. On July 8, Hashimoto is expected to take the first step by announcing plans for a new "bridge bank" that would take over banks' failed operations. The powerful institution would have the authority to send out inspectors to survey the damage around the industry and to fire poor managers. It would be empowered to sell off whatever loans and property from bank portfolios it could, and write off the rest. To generate market interest for the loans and real estate it needs to repackage and sell, the government might guarantee new asset-backed securities with the $2 trillion in postal savings system deposits.

Will it work? A lot depends on whether once the new plan is in place, Ministry of Finance officials really start pulling the trigger on banks that aren't solvent. "If the government gets serious, banks are going to fail," says a former Bank of Japan official. He estimates as many as 40 banks should disappear. And it's going to be expensive. Even the $210 billion-plus that the government has budgeted for replenishing the Japan deposit insurance system and shoring up the capital bases of the banks won't be enough once banks start folding.

POLITICAL RISK. But that pales in comparison to the political capital to be spent. For starters, the bailout measures will almost certainly extend the recession, pushing Japan's already historically high 4.1% jobless rate to Western levels. It also means a real thrashing for the most coddled domestic sectors of the economy: finance, real estate, and construction.

Even if Tokyo comes up with the right plan, it then must time its execution carefully. If it goes too fast, there could be a financial panic as depositors withdraw even more massive amounts of yen from the banking system. With the government's Big Bang overhaul of Tokyo's financial markets, outfits such as J.P. Morgan, Fidelity Investments, and others are ready to grab that money and place a good chunk of it in offshore markets with high returns.

Of course, if Hashimoto can restore some confidence and pull off Japan's makeover in a credible and orderly way, it "would mark a turning point for the crisis in Japan," figures Deutsche Bank economist Kenneth Courtis. But if the "Total Plan" is to be effective, there must be a major shift in the Japanese mindset, with everyone from lowly loan officers to mighty Ministry of Finance chiefs suddenly becoming more ruthless. Ultimately, that could spell the end of Japan's era of fail-safe capitalism.

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