WSJ Review & Outlook: [b]Fearing Japan[/b] April 24, 2002
There was a global sigh of relief at the beginning of April as Japan's fiscal year-end passed and the country's banking system remained intact, if as dysfunctional as ever. The fear had been that if the stock market were to fall too low, new accounting rules requiring banks to record assets according to their market value might reveal some to be insolvent. As in the past, however, the government engineered a temporary rise in the value of shares to coincide with March 31, this time by cracking down on short selling, and Japan limboed under the bar, safe for another year.
Or is it? The Financial Services Agency's recent, somewhat more stringent inspection of banks' balance sheets was intended to reassure everybody that Japan is finally serious about the bad loan problem. Instead, it actually raised more doubts because it uncovered so much rot while still failing to dig very deep. Standard and Poors last week downgraded Japan's sovereign debt to AA-minus, the lowest rating among the Group of Seven nations, and Moody's is expected to follow suit with a rating that puts Japan on a par with Botswana. At the G-7 finance ministers' summit last weekend, the other members were noticeably cool toward Japan as part of an ongoing effort to convey a sense of urgency about reform.
Meanwhile, Japanese Finance Minister Masajuro Shiokawa is responding to criticism with the kind of bluster the world expects from Beijing: Other nations are "meddling in Japan's domestic affairs," the International Monetary Fund's report on the economy was "unprofessional," the ratings agencies are "impulsive" and newspapers which criticize his government's performance are "not acceptable." Such posturing only increases the suspicion that Tokyo, like the Wizard of Oz, is desperately urging everyone to ignore the man behind the curtain. Can this charade continue much longer?
The relevant concern now is not Japan's lack of growth -- after all, that is something the world has learned to live with for more than a decade, and if the Japanese people lack the will to break the iron triangle of businessmen, bureaucrats and the Liberal Democratic Party, there isn't much outsiders can do. How Japanese allocate their losses is their business. But because they in fact refuse to allocate their losses, non-Japanese have to reckon with the small but growing possibility that a financial collapse in Japan will affect institutions elsewhere.
The danger of one bank failure causing others in a chain reaction is known as systemic risk, and due to the size of its economy, Japan's systemic risk is everybody's problem. That's why prudence requires that pressure be applied to Tokyo to concentrate on one reform above all others -- stopping its banks from sweeping their problems under the rug.
That the fudging continues is not seriously in doubt, and it doesn't involve just the bad loans themselves. Consider a small item in the April 15 Nikkei Weekly headlined "Major banks, life insurers infuse capital in each other." In what the Nikkei calls a "potentially dangerous trend," troubled banks and life insurance companies are passing money back and forth between each other and calling it capital.