JAPAN TIMES -- 23 January 2002

Get market forces on the side of reform

By STEVEN C. CLEMONS
Special to The Japan Times

There are episodes in history that deservingly draw our attention -- some very small in scale but major in impact. In American history, one such moment at the start of the Revolutionary War has come to be known as "the shot that rang through the world." Another such momentous event recently appeared in Japan which, wrecked by a decade-long economic malaise and the potential threat of a financial implosion, saw its Nikkei stock index rise on a day that it should have plummeted.

After the tragic terrorist attacks in Washington and New York, Tokyo's stock index rose, baffling those who noticed and were not otherwise glued to the visual images of airplanes crashing into skyscrapers. Why did the Nikkei move up? What could explain the breath of life in an otherwise flat and dreadfully stale Japanese economy? Prime Minister Junichiro Koizumi and his fellow LDP colleagues should have called a Diet hearing to investigate. Or perhaps the prime minister's economic policy czar, Heizo Takenaka, should have attempted some explanation as to why Japan's stock index seemed to power past the shock of the day's earlier traumatic events.

What triggered this shiver of hope was the bankruptcy of Japan's third-largest retailer, Mycal. Rather than prolonging by sleight of hand its insolvency, Mycal forced a real and transparent reconciliation of its deteriorating assets and accumulating debts. In contrast to the life support that the Japanese government and several lead banks continue to apply to Daiei, Mycal's action earned the applause and support of markets.

This is the shot that should ring loudly through the halls of Nagata-cho and Kasumigaseki, and frankly, throughout Japan. However, Koizumi -- despite his slick veneer as a reformer and rhetoric that he would protect "no sacred cows" -- has thus far utterly failed to make market forces his friend in changing the course of Japan's economy.

Many who interact closely with Koizumi report that though he has one of the keenest political minds in contemporary Japanese history, he is not very "numerate." He doesn't follow numbers and doesn't really understand the dynamics of an economy. As but one example, misunderstanding his advisers, Koizumi originally told Japan's citizens that he had a three-year plan for disposing of Japan's nonperforming loan problems (NPL), but he later revised this to seven years after correction from his NPL disposer-in-chief, Financial Supervisory Authority Minister Haruko Yanagisawa.

Nonetheless, the positive shock generated by Mycal's bankruptcy was not lost on all of the prime minister's close advisers -- particularly Hideiichi Okada -- a personal aide drawn from the senior ranks of the Ministry of Economy, Trade and Industry.

Okada gave access to the prime minister to a couple of clever economic realists from both the Diet and Japan's private accounting sector, who convinced Koizumi that economic confidence could be significantly strengthened if the lessons of Mycal's bankruptcy were applied to Japan's 30 worst nonperforming loans. Koizumi was on their side for at least two days before changing course again.

Focusing on the worst NPL cases would require the government to abandon the command economy tactics advocated by FSA boss Yanagisawa. The FSA's current approach is to generate a total figure of nonperforming loans, divide that number by seven (for seven years), and then write off one-seventh of Japan's bad debt each year. In the meantime, to better calibrate and understand the full scale of the problem in Japan's financial sector, Yanagisawa is playing the role of good bureaucratic chief -- asking for an expansion of his budget, a broadening of his powers, and a massive expansion of his inspector team.

At best, however, Yanagisawa's plan is disingenuous and a distraction from real problem solving as it fails to account for the accumulation and compounding of bad loans beyond current levels.

His plan also rests on the notion of informally dispersing "bad debt target levels" to Japan's financial sector -- allowing them only to write off a certain limit of NPLs each year. In other words, Yanagisawa has constructed a framework in which the government will essentially be directing banks to write off some loans but then misclassify other parts of its portfolio until the next year's bad debt targets are dispersed and approved.

Very few seem to be noting that Yanagisawa seems to be putting the government in the position of being a party to the fraudulent management of loan portfolios.

The beauty of the Mycal bankruptcy and the "30 worst NPLs plan" is not that the government and private sector can acknowledge that the resolution of Japan's debt problems will take years to resolve but that this strategy will clear the worst cases off the books first.

Markets rise and fall based not on current conditions but based on future projections. If Japan steps forward to work out the most bleak parts of its bad debt portfolio, markets may believe that this bodes well for sound economic decisions in the future.

Yanagisawa's annual allotments of bed debt write-offs could also be overwhelmed by other unforeseen, unmanaged bankruptcies, compelling even more strident government guidance to the banks not to be honest about the true state of their loan portfolios.

Just as markets can spiral down, triggering further cascading spirals downward, they can also spiral upward. If Japan worked harder to get market forces on the side of reform, stopped trying to convince the world that the nonperforming loans would disappear by some unrealistic date and worked to resolve the worst cases first, confidence might return on the basis of a brighter future down the road.

Such a boost would stir new investment, drive consumption, and potentially kick start the Japanese economy -- thus bestowing on those at the helm of state the deserved accolades as "reformers."

Steven C. Clemons is executive vice president of the New America Foundation, a centrist public policy institution in Washington, D.C. He is also a task force member of the "Understanding Tomorrow's Japan" Task Force of the Pacific Council on International Policy, which is holding its first meeting in Tokyo this week.

The Japan Times: Jan. 23, 2002