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Horror Show Japan Bad Journalism*

Japan's Horror Show

Why its financial crisis is even scarier than you think.


Monday, November 25, 2002

By Clay Chandler

Battles to slay the corporate zombies haunting the Japanese financial system have the gruesome predictability of a grade B creature feature. The monsters get uglier and more destructive--and they keep coming back.

Little wonder, then, that the infighting over the most recent reform plan rolled out by Japan's new banking czar, Heizo Takenaka, drew little interest outside Japan. The story line was all too familiar: A dashing Prime Minister enlists the aid of an economic whiz in a valiant struggle to save Japan from financial calamity, only to be eviscerated by capital-sucking borrowers and wicked politicians. Haven't we seen this flick before?

Well, maybe. But consider the possibility that this trailer for Japan's financial horror film doesn't do justice to the plot. Sure, the political battles behind the October reform plan had the familiar gory ending. But much of the action along the way was new. And the real story is scarier than you might think.

Take the drama's opening scene: Prime Minister Junichiro Koizumi's Sept. 30 decision to lop off the head of his banking czar, Hakuo Yanagisawa. A foot-dragging legislator from a conservative faction of Koizumi's Liberal Democratic Party, Yanagisawa seemed the perfect ogre. He had stalled reform and all but abandoned his early insistence on stricter accounting standards. The Western press portrayed the replacement of Yanagisawa with Takenaka as a sign that Koizumi was still fighting the good fight.

But Japanese media accounts suggest a less inspiring interpretation--that Koizumi dumped Yanagisawa to mollify President George W. Bush. That contradicts the official line from Washington. Bush vowed never to interfere with Japanese policy, lambasting his predecessor during the 2000 campaign for nagging Japanese officials about the punk performance of their economy. True to his word, Bush offered wholehearted support for Koizumi's reform efforts (despite the lack of progress) during his visit to Japan in February. A White House aide categorically denies that the administration pressed for Yanagisawa's dismissal or otherwise meddled: "We read this stuff all the time in the Japanese press, and it's just not true."

But Japanese officials insist that behind the scenes Bush has begun prodding Koizumi to get off his duff. Koizumi aides say Bush gave the Prime Minister an earful about the bad-loan mess in a Sept. 12 meeting at the United Nations and that his vehemence caught Koizumi by surprise. Council of Economic Advisors chairman Glenn Hubbard and Treasury undersecretary John Taylor reinforced the message by heaping praise on Takenaka. During a visit to Tokyo in October, Taylor told reporters he was heartened by reports that Takenaka favored a bold approach. "I agree very much with these principles," he said.

The former Japanese vice minister for international finance, Eisuke Sakakibara, now head of a private think tank but still known as "Mr. Yen," says Japanese officials have told him that Hubbard and Taylor made specific demands for changes in Japanese banking policy that, in his words, "go far beyond anything ever said to me by [Clinton Treasury Secretary] Larry Summers." Antireform LDP legislators, joined by xenophobes in the tabloid press, have taken the charge a step further. Takenaka, they allege, is part of a plot to drive down the price of Japanese assets. He "is nothing better than an agent of the vultures," declared LDP faction boss Shizuka Kamei, referring to U.S. investment funds circling over the wreckage of Japan Inc. Okay, that's more than a little paranoid, but it doesn't take Oliver Stone to suspect the Bush administration of playing more than a cameo role in the most recent installment of Japan's long-running reform saga.

In reel two, we find Takenaka, the mop-topped, Harvard-trained genius with a cherubic smile, hard at work on his dramatic reform proposals to rescue the Japanese banking system. The climactic scene is a monster mash set at LDP headquarters Oct. 22, the day before he is to present his interim report. As he briefs party leaders, Takenaka is attacked by a phalanx of aging conservatives enraged by the notion that an unelected academic should be permitted to draft legislation that might threaten the party's hold on power. They order him back to the drawing board.

But Takenaka is not quite as heroic as this script implies. His plan had a crucial flaw: It failed to acknowledge the political dimension of reform. Measures designed to force banks to cut off weak borrowers, for example, weren't matched with adequate provisions to shield workers and consumers from the inevitable deflationary downdraft. And Takenaka antagonized bankers, borrowers, and bureaucrats alike by devising the program in strict secrecy.

Opponents of reform smelled trouble when Takenaka included Takeshi Kimura on his team of private-sector advisors. Kimura, the head of the Japan office of KPMG Financial, is a controversial former Bank of Japan official with a reputation as a slash-and-burn radical. In books, essays, and television appearances, he has demanded aggressive bank write-offs, even at the risk of triggering a tsunami of business failures.

The teeth-gnashing began when bankers learned of Kimura's plans for rewriting tax and accounting rules. Japanese banks can now include, as part of their core capital, up to 40% of the tax refunds they expect to get from the government for writing off bad loans. Kimura urged that Japan adopt the stricter U.S. standard of 10%. The difference seems arcane, but the implications are huge. Anticipated tax refunds constitute half of core assets at Japan's big banks. A 10% ceiling would have forced lenders to seek public funds just to remain in compliance with international capital standards.

The rationale for lowering the cap was to hold Japanese banks to world accounting practices. But the proposal's real aim was to bring bank management to heel. Goldman Sachs analyst David Atkinson argues that the 10% rule would only increase the ranks of zombie borrowers. For banks, he reasons, pushing a weak firm into bankruptcy brings some gain--lowered exposure to risky loans--but also a heap of pain: the need to renounce all claims on loans to the deceased borrower and make up the losses by selling core assets. Many banks would therefore opt to pare loans to viable companies to subsistence levels, even as they dribbled out just enough credit to keep the really hopeless firms afloat. In any case, Takenaka's final reform plan, released Oct. 30, promises only to "study" proposals for limiting bank reliance on tax-deferred assets. Other changes that would have tightened rules for valuing bank loans were watered down. In the end, his attempt at reform turned into what one credit-rating agency called a "damp squib."

So how will Japan's financial saga end? That's impossible to predict, in part because the head Ghostbuster is something of a phantom himself. The common perception of the Prime Minister is that he is eager to overthrow the old order but hemmed in by powerful adversaries. The truth is that with approval ratings around 70%, Koizumi has ample political capital. But rather than support Takenaka, he has opted to hover above the fray, even as Japan's bad-debt problem has worsened.

The most recent installment of the horror show that is Japan's slow-motion descent into the economic slime is not just another episode. The LDP's internal battle over the Takenaka plan transformed the economic-policy landscape in much the same way that Clinton's bungled attempt at health-care reform took the subject off the agenda for years. The skirmish may well have been Japan's last, best shot at tackling its banking troubles. And this battle of the zombie borrowers may have only set the stage for a really frightening denouement in the months ahead.

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