Japan's Desperate Deals
Old Japan hands thought they would never see such deals in the closed, slow-changing world of Japanese finance and business. U.S. financial giant General Electric Capital Services Inc. pulls off a $6.5 billion takeover of Japan's biggest leasing company in the country's largest foreign acquisition ever. Goodyear Tire & Rubber Co. suddenly emerges as Sumitomo Rubber Industries' white knight. A debt-burdened Nissan Motor Co. effectively puts itself in play. Keiretsu group relationships fall apart as Japanese banks and brokers engage in a bewildering array of novel mergers and tie-ups. A new financial-reconstruction czar, Hakuo Yanagisawa, orders a massive reorganization of Tokyo banks and forces a shotgun marriage between Mitsui Trust & Banking and rival Chuo Trust & Banking.
These deals are a prelude to an even greater upheaval in Japan, marked by restructurings, asset sales to foreigners, and bank mergers. This great change is coming not because Japan's mandarins want reform: They probably don't. Instead, the transformation will occur because Japan's trillions in wealth are a far weaker bulwark against change than anyone has imagined. The country is running out of money to prop up its tottering network of bankrupt banks and profitless companies--and absorb at least $600 billion in bad loans. The only solution is to weed out weak companies and reluctantly or not, invite in foreign capital. "Only companies in real distress would look at such deals with foreign partners," says Mitsubishi Corp. Chairman Minoru Makihara.
Skeptics think these deals are window dressing, an attempt to convince gullible foreigners that Japan is serious about reform. They argue that with $10 trillion in domestic savings and $1 trillion in overseas assets, Japan can resist real reform for years.
Yet a powerful force is pushing the workouts: The growing belief that the government cannot continue to bail out sick companies, as it has through innumerable subsidies over the past 10 years. Prime Minister Keizo Obuchi's government thinks it can readily raise $500 billion for fixing the banks and earmark another $200 billion in easy credit to companies, tax breaks to consumers, and public works to benefit the sprawling construction industry. But raising that $700 billion could prove prohibitively expensive. And even if Obuchi pulls it off, this budget may be the last serious rescue package the government can afford. That's because some analysts think only some $1 trillion of Japan's $11 trillion in wealth can be tapped to bail out Japan Inc.
It's hard to square this parlous state of affairs with the stories of Japan's wealth. Couldn't Tokyo just tap into those trillions by issuing an endless stream of government bonds? Then, the Ministry of Finance could keep bailing out banks and companies with the proceeds. That's what the government hopes to do--but investors are already getting spooked. Long-term rates have doubled since last fall, as bond traders wonder how a projected 50% increase in bond issues will be absorbed by the market. MOF's Trust Fund bureau, which manages $3 trillion in postal savings and premiums from state-run insurance programs, has already said it can't absorb much of the new demand.
Some politicians want the Bank of Japan to print money to buy all these bonds. That's a scary idea, since years of wasteful public-works spending have already driven up Japan's gross debt level to 110% of gross national product. It could reach 140% by 2002. This estimate doesn't even factor in the latest bank bailout plan or billions in off-balance-sheet loans and pension shortfalls. "The real millennial time bomb will be the collapse of Japanese government finances," warns David Asher, a Japan research fellow at Massachusetts Institute of Technology.
OFF THE TABLE. To understand why, you need to deconstruct the quality of Japanese assets abroad and its obligations at home. It's true that Japan holds $1 trillion in net assets overseas, and theoretically, it could bring that money home to shore up the system. Yet roughly $800 billion of that is owned by companies in the form of private direct investment, such as real estate, factories, and securities. Much of that money is off the table. The government can't really ask Toyota Motor Corp. to sell off a truck plant in Indiana and invest the proceeds in Japanese government bonds. And a big chunk of this money is sunk into factories in Asia. These plants have lost much, if not most, of their value, and some of the loans backing them have gone bad.
Meanwhile, the balance of some $220 billion represents the Bank of Japan's foreign-exchange reserves, most of it parked in U.S. Treasuries. Yet BOJ needs these dollar reserves as ammo in its periodic fights to influence the strength of the yen. The upshot is that Japan's overseas assets will be of little use as the funding crisis grows at home. That wealth only gives a false sense of security and lets authorities put off the "massive economic restructuring" the nation desperately needs, says Bert Ely, a monetary specialist in Arlington, Va.
The other pots of money in Japan can't help bail out the system, either. MOF's Fiscal Investment & Loan Program, or Zaito, has historically recycled some of the $3 trillion in postal savings into the government bond market. Now, that money is already earmarked for emergency loans to the corporate sector and won't be available for the bonds the government desperately needs to sell. Nissan received a $730 million loan from the Japan Development Bank, which usually lends to small companies. Overall, the government has set aside $46 billion for loans and loan guarantees that JDB and other quasi-public financial institutions will provide to Corporate Japan. MOF wants to steer an additional $17 billion of Zaito funds to small companies starved for credit.
Worse, some $1 trillion worth of the postal savings is parked in long-term certificates earning 5% on average. Those certificates expire soon. Because deposit rates have fallen to 1% since 1995, "maybe half of that will be withdrawn," frets one senior official in MOF's financial bureau. That means authorities will have much less money to throw at troubled banks and companies.
Finally, Zaito has lent much of the postal savings funds to questionable infrastructure and real estate projects. Analysts figure Zaito has to write down or write off a third of that sum, given the drastic decline in property prices and years of stagnation. MOF vigorously denies there is a bad-loan problem at Zaito. But Merrill Lynch & Co. economist Ronald Bevacqua notes that Zaito is projecting a $28 billion decline in income for loan repayments this year--a sure sign of trouble.
NEST EGG. The $3 trillion on deposit in the postal savings system is part of Japan's $10 trillion in household financial assets. The authorities can conceivably draw against this $10 trillion in the fight to save Japan Inc. But that number quickly dwindles on examination. The postal savings money is already tied up in the Zaito mess. Households have another $3.5 trillion worth of home mortgages and other debts to service. The remaining $3 trillion is sitting in other banks. Much of that is nest-egg money the Japanese are hoarding against shortfalls in private and public pension schemes that are projected to hit 100% of gross domestic product. Banks are loath to put these precious funds into bonds earmarked for bailouts.
The mismatch between Japan's assets and liabilities is alarming. "These numbers have never been witnessed before in an industrialized economy," says Vincent Truglia, a former New York Fed official and managing director of Moody's Investors Service. Last year, the rating agency dropped Japan's AAA sovereign debt rating a notch--and he doesn't rule out further downgrades.
Executives at Japan's banks and companies know these numbers, too. Some are scrambling for government aid before it dwindles away, while others are taking steps to raise cash fast. To get government funds, banks that once vowed to remain independent are merging. Some companies are selling off the family silver. Japan Airlines Co. decided last month to sell off its trophy Essex House in midtown Manhattan for $250 million to Chicago-based Strategic Hotel Capital. Giant retailer Daiei Inc. is trying to unload the upscale Ala Moana Shopping Center in Honolulu to free up funds it badly needs at home.
At this scary stage, foreign money is looking more attractive. Japan has become "very collaborative and very open to new ways of thinking," as GE Capital President Denis J. Nayden delicately puts it. Distrust of Japanese financial and corporate management now runs so high that teaming with foreign players could even help shore up public confidence. "If a foreign bank buys a Japanese bank, it's more safe," says Citizen Watch Chairman Michio Nakajima.
That's ironic. Finance ministers in the West have hectored Japan for years to get tough on its banks and let in foreign investors. It never did any good. But the prospect of running perilously short of funds has given the Japanese a focus they long lacked.
They have to keep that focus. Subtract all the wealth unavailable for more bailouts, and Japan may have $1 trillion or less to work with in shoring up its financial system. And if all the possible liabilities come due--the pension shortfalls, the big loan write-offs--then sometime before 2005, Japan may not be able to raise all the money it needs. That's the kind of solvency crisis that gives regulators and executives nightmares. The only answer is to merge banks, sell companies, and restructure. It will be a long and painful workout.