A Nordic Track to Japanese Bank Reform
By Brian Bremner
For years, everyone from former U.S. Federal Reserve Chairman Paul Volcker to L. William Seidman, former head of the Federal Deposit Insurance Corp., have been winging to Tokyo, offering all sorts of advice to financial authorities about how to fix their debt-besotted banking system. And they would usually point to the cleanup of the U.S. savings and loan mess in the early 1990s as a model to get the job done.
While that experience does offer some lessons -- and something like a U.S. style-Resolution Trust Corp. to recycle dud loans and their collateral from thrifts to private investors is now being tried in Japan -- other examples out there may be more relevant to the country's world-class mess. Japan's $600 billion to $1 trillion in suspected nonperforming loans dwarf the $150 billion the U.S. had to cope with a decade ago.
That's why Prime Minister Junichiro Koizumi and his economic mandarins ought to get their hands on a speech given in Tokyo on Feb. 26 by Bo Lundgren, who served as Sweden's Minister for Fiscal & Financial Affairs during the early 1990s. He was one of the prime architects of his country's surprisingly successful job of salvaging its ailing banks.
Now you may be wondering: What can a middling Nordic country teach the $4.5 trillion Japanese economy? Plenty, it turns out. Just like Japan, Sweden suffered from a speculative run-up during the second half of the 1980s, in which everyone kind of lost their heads. Property prices doubled, the banks lent recklessly, and private-sector debt shot up from 100% to 150% of gross domestic product.
Again mirroring Japan, the party abruptly ended in 1990. "Sweden's financial sector was in a profound crisis," recalled Lundgren. "All in all, the loan losses in those years added up to approximately one-fifth of the total loan stock, which was equivalent to 12% of Sweden's annual GDP." Japan's nonperforming loan problem is pegged by private analysts at 15% to 20% of total economic output.
In short, the crisis that Lundgren confronted in relative terms was roughly the same magnitude as Japan's. The only difference -- and it's a pretty big one -- is by the mid-1990s, Sweden had pretty much fixed its banks. In Japan, it has been kind of like the movie Groundhog Day, in which a TV weatherman played by Bill Murray relives the same day over and over again. Japan's sob story is now heading into its second decade.
Though Lundgren doesn't dwell on Japan in his speech, it's not too difficult to see where Tokyo screwed up big-time. Here are the major lessons that Sweden has to offer its friends in Japan.
Just Do It: Lundgren and his team quickly set about studying banking mishaps throughout economic history and delved deeply into the academic literature regarding the worldwide recession in the 1930s. They immediately concluded that if they didn't take decisive action right away, "the financial crisis may become very serious, protracted, and very costly to resolve."
Japan spent the early 1990s denying much of a problem existed, the mid-1990s taking baby steps by bailing out small lenders, and then the latter part of the decade putting out big fires. In 1997 and 1998, some major players, such as Long Term Credit Bank of Japan and Nippon Credit, collapsed. Only then did authorities get serious, but it took years of stagnant growth in part due to a very sick banking sector.
Come Clean: This is critical and, unlike Sweden, Japan has done a miserable job here, as well. You can't really end a banking crisis until you first properly define how bad things really are. That means strict loan classifications, which state clearly that this borrower is O.K. and that this one isn't long for this world. It also means valuing a piece of real estate or some other asset serving as collateral for a loan at prevailing market rates -- as opposed to, say, some half-baked belief that a big real estate rally is right around the corner.
Lundgren concedes there was some talk of fudging and deferring losses for another day, but that would only have prolonged and probably worsened the cathartic workout later. Instead, "A great deal of work began on valuing loans and collateral in each bank in order to arrive at a need for support that could be provided without delay."
To get there, Sweden set up a Bank Support Authority to do reality testing on the loan books of Sweden's biggest banks. It also set up a board of very clear-eyed valuation experts who had a pretty good idea of what office towers in Stockholm were actually fetching in the early 1990s.
Though Japan has made some big steps forward in regulatory oversight and loan classification, it needs to do much more. Nobody believes the government's figures that Japanese banks have systemwide problem loans in the $300 billion range. An additional $700 billion in so-called classified credits or loans also needs watching.
A big chunk of those loans probably have soured, but neither the banks nor, as of yet, the regulators at the Financial Services Agency in Tokyo have been willing to reclassify such loans. Critics also wonder about the true value of the real estate backing those loans. The suspicion is that bank executives have placed Alice-in-Wonderland valuations on those properties.
Get Everyone on Board: Again, Lundgren sums it up best: "Broad political consensus and resolute political actions taken by the political system are probably more important than any of the technical aspects on how to deal with the crisis." In Sweden's case, Lundgren's nonsocialist coalition government worked very closely with the Social Democrats in the opposition.
In the end, they came up with a three-pronged approach based on the major Swedish banks' real level of need to avoid a systemic collapse that would have completely blindsided the economy. Some banks received state support. Others had to fend for themselves. The state-owned Nordbanken was overhauled by the government and merged with smaller banks, Lundgren points out.
Japan, however, is still in a state of denial. Pick up a newspaper, and you'll hear a cacophony of views from Koizumi's own economic team about 1) the severity of the banking problem, and 2) the need for yet another injection of taxpayer money. It's a house-of-mirrors approach to policy that has left global investors in a state of utter confusion. Even today, it's hard to say what exactly Japan has in mind to fix its banks.
What's most maddening about Japan's situation is that its banking mess is fixable. Sure it's going to hurt, but plenty of other economies -- including Norway and, to a lesser degree, Britain and the U.S -- have come through such crises through just fine.
Please, Mr. Koizumi: If you haven't yet, get your team together with Lundgren -- for your sake, as well as Japan's.
Bremner, Tokyo bureau chief for BusinessWeek, offers his views every week in Eye on Japan, only for BusinessWeek Online
Edited by Beth Belton