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Banking on Japan

by Jeff Kingston

SAVING THE SUN: A Wall Street Gamble to Rescue Japan From Its Trillion-Dollar Meltdown, by Gillian Tett. New York: Random House Books, 2004, 2,940 yen (paper).

This is a remarkable saga about the demise of Long Term Credit Bank and its improbable recovery as Shinsei Bank. It is a story about the Japanese vision of the role and purpose of banks and the perils of globalization. It is also a cautionary tale about the limits of reform.

Why and how did an obscure U.S. venture capital firm named Ripplewood buy LTCB? Drawing on extensive interviews with many of the main players, Gillian Tett gives us an insider’s view about what went terribly wrong at LTCB and why this eventually led to a “vulture fund” swooping down on the carcass of one of Japan’s venerable banking institutions.

The problems of LTCB were the same as those that have rendered all of Japan’s banks awash in bad loans: They all piled into the frothy real estate market in the 1980s, lending with abandon and no credit-risk assessment. Like lemmings dismissing rumors about a cliff ahead, Japanese bankers repeated the mantra that land prices always rise — our collateral is solid.

When the Bank of Japan raised interest rates, beginning in late 1989, the house of cards came tumbling down. Heavily indebted firms could no longer pay their debts, and the value of land pledged as collateral could not cover the loans. One of LTCB’s largest borrowers, EIE International, sank beneath the debts amassed from a global resort and hotel empire.

This is a colorful and tawdry tale where it is hard to determine who was conning whom. Since all of the banks had rumbled along with the herd, they all faced the same troubles, meaning that there was systemic risk.

Everyone — the borrowers, bankers and bureaucratic overseers — had an interest in keeping a lid on this story and so pretended as if nothing was wrong. Tett writes: “By adopting an ostrich-like approach to policymaking in the last decade — and refusing to take painful decisions — Japan has not made the challenges go away. Nor has it made them less painful or costly to deal with. The biggest single lesson from LTCB . . . is that collective policy denial and procrastination can carry a terrible cost.”

Approving more loans to troubled borrowers so that they could maintain the pretense of servicing their loans — throwing good money after bad — was the fateful alchemy of Japanese banks in the 1990s. Thus Japan’s zombie companies transformed their lenders into zombie banks, all kept on government life support. Pumping money into the system postponed the day of reckoning, but also meant there were no incentives for restructuring or dealing with bad loans.

The reincarnation of LTCB as Shinsei is making many foreign bankers and investors rich. Tim Collins, Ripplewood Holdings CEO, together with Christopher Flowers, former Goldman Sachs investment banker, parlayed political connections, intense lobbying and expertise in deal-making to mount a successful bid, scooping up LTCB at a fire sale price in 1999.

Paul Volker, David Rockefeller, Vernon Jordan and Tom Foley are some of the U.S. “rainmakers” who lent their support and made the deal possible. Tett suggests the deal went through despite strong reservations about a foreign takeover because there was a sense among Japanese participants that it enjoyed the imprimatur of the U.S. government. That is also why, subsequently, the deal has been savaged in the media as a Trojan Horse of unwelcome “creative destruction.”

Unlike in the United States, in Japan there is scant faith that personal greed can be harnessed in the service of the public interest, or that markets have the answers, or that bankruptcies are a necessary medicine. Ironically, by trying to preserve the appearance of stability at all costs, Japanese regulators and bankers fostered instability and nearly triggered a meltdown.

By apparently embracing reform but then refusing to accept the consequences of reform, they appeared to be both in denial and duplicitous. Japanese saw the foreign bankers as greedy opportunists, while the foreign bankers dismissed their counterparts as clueless about banking, hiding their “Monty Pythonesque” incompetence behind cultural smoke screens.

Tett points out that the controversial “put” option whereby Shinsei was allowed to return certain soured loans to the government was actually suggested by government officials. This proviso protected Shinsei from time bombs it inherited from LTCB and was a price the government was willing to pay to prohibit due diligence.

But when Shinsei exercised this option, it was skewered in the press, cold-shouldered by other banks and strong-armed by the government. Politicians had a field day slamming the deal and the foreign interlopers, tapping into public resentment against taxpayer bailouts of banks and xenophobia. Shinsei seems to have been guilty of playing by the rules of the negotiated contract while ignoring that the government is accustomed to rewriting the rules as it goes along.

Shinsei’s success story (it did swiftly clear up its loan books in three years, returning $10 billion in bad loans to the government while “fixing” an additional $17 billion on its own) remains underappreciated. As one prominent detractor pointed out, “the only thing that Americans are interested in is short-term profits and getting the returns they promised their investors. That affects their entire strategy and thinking. So can they be a good role model for Japan? I have lost my faith in that idea.”

Coming from the lips of Michio Ochi, a powerful politician and former head of the Financial Supervisory Agency, this suggests that many of the attitudes and inclinations that propelled Japan’s banks to the abyss persist. The Resona debacle and UFJ’s gathering problems suggest that the financial sector remains riddled with time bombs. Is it better to defuse or explode these bombs a la Shinsei or bury them in the hope of muffling the explosions?

Tett masterfully explains how and why Japan is at this cross-roads and why a turnaround remains elusive. If Shinsei’s spectacular initial public offering earlier this year is any indication, it appears that investors are buying into its performance and the methods that got it there.