Japan Is Hampering Its Own Recovery

Prime Minister Yoshiro Mori's government is to be congratulated for allowing department store chain Sogo Co. to go bankrupt. Just days before, the government had announced plans to forgive a huge amount of bank debt issued to Sogo, sending the wrong signal to both domestic and international investors. Despite measurable progress in reforming its corporate and banking sectors, Japan has acted glacially in restructuring its economy, extending its already protracted recession and weakening its recovery. A government bailout of Sogo would only have continued that go-slow policy.

Indeed, had market forces been allowed to act, chances are that Sogo would have gone bankrupt years ago. It overexpanded in the bubble economy of the 1980s. When weak consumer spending hit in the 1990s, a huge debt load crushed the company. Many other Japanese companies are in the same situation.

Tokyo's reputation has still taken a considerable hit. It initially rationalized a Sogo bailout by saying it was needed to prevent another meltdown in the banking sector. If this is true, it is a shocking statement. After years of obfuscation about the true extent of bad loans and promises to write them down, Japanese leaders had assured Western officials that its banks were finally healthy and ready to begin lending again.

But if the government is still trying to protect the banks, it implies that reserves had not been set aside for the Sogo loans and the loans had not been written down. How many more billions of bad debt are out there, weighing down bank balance sheets? Worries about the extent of unreserved loans on the books of Japanese banks are already the talk of central bankers around the world. Concerns about transparency are arising all over again, and Japan's promises about financial reform are being questioned.

Undisclosed and unreserved loans may be one reason why, after so many years, Japanese banks are still not making many consumer credit loans. The lack of strong consumer demand has been a major factor in the country's anemic recovery. And extending credit to consumers is essential to stimulating demand and economic growth.

Japan's return to economic health is taking far too long. A few dozen new Internet companies and a couple of successes like NTT DoCoMo should not blind the government to the need to accelerate the pace of corporate and financial reform. Bad bank loans that remain hidden from view after all these years are not a reassuring sign of progress.

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