MW-20 -- CROCODILE TEARS

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J@pan Inc Magazine Presents:
M O N E Y W A T C H
Weekly Financial Commentary from Tokyo
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Issue No. 20
Tuesday, March 18, 2003
Tokyo

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Viewpoint: CROCODILE TEARS

The Bottom Line:

o While even the government was wise enough to back off of a
huge new issue of stock by Japan Tobacco in light of poor
market conditions, Japan's major banks have ignored the
horrible market supply-demand conditions and market principles
as they scrambled to shove 2 trillion yen of new scrip down
the throats of reluctant investors and banking clients.

o The real motivation for the capital increases was the threat
from "hardliner" Financial Services minister Heizo Takenaka to
nationalize any bank not making the grade under a new
Financial Revival Program. In the words of a Bank of Japan
official, the banks "rushed to adopt capital increases without
bothering about appearances."

o As predicted in last week's edition of MoneyWatch, the
Japanese government has belatedly responded to the fall in the
Nikkei 225. While there is an outside possibility that this
could be the big one in terms of a real crisis, MoneyWatch
suspects that all this sudden concern about the stock market
after months of neglect by old-line LDP politicians is merely
crocodile tears for their large corporate contributors and the
voting public, who will go to the polls in April.

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CROCODILE TEARS
Continuous Alarm Bells Finally Awake the Government
While even the government was wise enough to back off of a huge new
issue of stock by Japan Tobacco, Japan's major banks also ignored the
horrible market supply-demand conditions and market principles as they
scrambled to shove 2 trillion yen of new scrip down the throats of
reluctant investors. The object of the exercise was to strengthen
their financial condition to prevent their capital-adequacy ratios
from falling below the 8-percent level stipulated by the Bank of
International Settlements (BIS) for "internationally active" banks.
The deterioration of BIS ratios was itself the consequence of the
disposal of bad loans and the valuation losses they expected to record
in their stockholdings. But the real motivation for the capital
increases was the threat from "hardliner" Financial Services minister
Heizo Takenaka to nationalize any bank not making the grade under a
new Financial Revival Program. In the words of a Bank of Japan
official, the banks "rushed to adopt capital increases without
bothering about appearances." When the major banks accepted the
injection of public funds in 1999, many of them issued preferred
stocks with no voting rights to the government.

Takenaka made it fairly clear that the government would not hesitate
to convert these preferred shares into ordinary shares with voting
rights if these preferred shares did not yield dividends. Thus another
reason the banks were scrambling was to procure funds to pay
dividends. In addition, new, tougher accounting rules contained in the
Financial Revival Program take effect on April 1. Under the
guidelines, banks would be required to deem worthless many of the
questionable loans listed on their books as recoverable assets. Later
reforms would ostensibly restrict the dubious practice of counting
future tax refunds as current assets. The new rules threatened to put
the major Japanese banks in imminent danger of failing to keep their
ratio of capital to assets above 8 percent; that is also the magic
number at which the Financial Services Agency (FSA) could forcibly
recapitalize a bank or place some operational control in government
hands. With all the bad news coming out of the banks and with
Takenaka's surprisingly persistent cleanup efforts, many observers
began to believe late last year that nationalization was a foregone
conclusion for the weakest banks.

Mizuho in the Cross Hairs
At the center of all the speculation over possible nationalization of
a major Japanese bank was the Mizuho Financial Group. Mizuho was
already on the regulator's hit list. From May 8 to June 5, 2002, the
Bank of Japan conducted an on-site examination of Mizuho Corporate
Bank and notified it of the results on June 11. Based on the results
of the examination and other FSA inspections of Mizuho Holdings and
Mizuho Bank, the the agency issued a business improvement order to
Mizuho Financial Group. The bank was ordered to improve its computer
systems and operational procedures without delay and strengthen its
management operating system as the bank had caused confusion in the
financial payments system earlier last year when its computer systems
failed to function properly.

Nor are they likely to win praise from the regulators any time in the
near future. Mizuho moved to procure a record 1.08 trillion yen from
3,500 domestic corporate clients by issuing three types of preferred
shares that carry no voting rights. Corporate borrowers of Mizuho
Financial were put in a difficult position by the bank's plan to raise
a massive amount of capital. The borrowers' close ties with the bank
made it almost mandatory for them to offer some fresh capital, while
they had to consider how to deal with strong opposition from their
shareholders. Under the Securities and Exchange Law, Mizuho was not
allowed to ask its borrowers for new investments until February 6, when it
formally decided on the capital increase.

However, those close to the situation have indicated that the bank had
started approaching its customers well before that date. As the
details of its capital increase plan became available, Mizuho's
officers scrambled to ask corporate borrowers whether they would
supply the bank with new capital. Most of the bank's borrowers ended
up agreeing to purchase new shares, but it was not easy for them to
arrive at their decisions. Many of the borrowers felt that they had
insufficient financial resources to provide as much capital as they
were being asked to provide.

Potential lawsuits by shareholders were a real concern for Mizuho
borrowers. Already hit hard by plunging prices in their bank and other
stockholdings, subscribing companies needed to demonstrate to their
stockholders that Mizuho had a solid foundation from which to improve
its operations. Some companies actually received angry telephone calls
from shareholders every time there was a report that the company would
provide capital to the bank.

Foreign investors were not buying the Mizuho story from the onset. The
bank had planned to procure up to 150 billion yen from foreign
investors, but when the bank's management found out that hedge funds
had purchased large amounts of shares on the stock loan market, they
realized that pushing ahead with an overseas share issue would have
resulted in a steep decline in the stock price. Mizuho was looking at
losses for this fiscal year of 1.95 trillion yen, versus an initial
forecast of 220 billion yen in losses. These massive losses are
ostensibly the result of the disposal of 2.03 trillion yen in bad
loans. The bank also increased its sales of stock held to 1 trillion
yen. Additionally, by bringing forward the strict application of
tax-effect accounting under the Financial Revival Program, Mizuho
postponed the inclusion in its capital of 800 billion yen worth of
deferred tax assets. All this, of course, pointed to a substantial
deterioration in the bank's regulatory capital ratio.

On February 21, the FSA released its policy regarding bank capital
increases through third-party allotments. There was a great deal of
interest in the policy because of numerous tough-sounding statements
made by Takenaka. The guidelines covered six areas: basic management
policy; prevention of unfair transactions based on the abuse of
domestic bargaining position; an explanation of the appropriate
pricing of the issue; an assurance of adequate disclosure; and the
status of policies taken to ensure continued compliance after the
issue. According the Takenaka, "The guidelines were created to ensure,
within the outlines of the Commercial Code, that the capital increase
contributes to a sounder financial position, that there is no abuse of
a bank's dominant bargaining position with borrowers, that appropriate
disclosure is made, and that the issues are in the interest of
investors." He emphasized that "if the guidelines are disobeyed, we
(the FSA), as the governing agency, will not hesitate to take
appropriate action."

While not a third-party allotment, the huge capital call by Mizuho
came very close to violating these guidelines. Yes, the issue will
provide a sounder financial position for the bank, but this came
essentially through the abuse of the bank's dominant bargaining
position with borrowers, and it is questionable if investor interests
were best served by the issue.

Derailing the Hardline Approach
As predicted in last week's edition of MoneyWatch, the Japanese
government has belatedly responded to the fall in the Nikkei 225. Late
last week, the FSA hurriedly slapped together a six-point market
stabilization plan that was totally unimpressive but is only the first
in a series of expected government emergency countermeasures. But it
is virtually impossible for the government to implement new fiscal and
financial steps while fiscal 2003 budget proposals have not yet passed
the Diet.

The points of the plan are:
1. "Rigorous" market surveillance, which the stock exchanges are
ostensibly already doing
2. Ensuring proper price formation
3. Stricter risk management of dealings by securities companies
4. Relaxation of regulations on corporate stock buybacks
5. Ensuring proper management of funds (management of stock
lending) by institutions (i.e., cracking down on stock loans
to squeeze the hedge funds)
6. Request for due consideration for stock markets on selling
shares (i.e., discouraging institutions from aggressively
selling shares).

It is ironic that the FSA has instructed the Securities and Exchange
Surveillance Commission (SESC) to "rigorously" pursue violations of
the Securities and Exchange Law, when Takenaka himself was accused by
opposition politicians in early February of violating this very law by
"spreading rumors" when he recommended to his fellow cabinet members
to buy exchange-traded funds (ETFs). "Yes, I will be buying. You can
definitely make money with ETFs," Takenaka said at the time. His
remarks were posted on the FSA's official Web site.

Compare the above countermeasures with Takenaka's comments about a
"March crisis" in early March. Then, Takenaka insisted that the
Japanese government would not allow a "March crisis" to occur. "If an
Iraq war begins, we will need to carefully monitor oil prices, the
impact on personal consumption and stock prices. But if military
action is short-lived, there is no need to become excessively
pessimistic. However, given the banks' nonperforming loans, if
(because of falling stock prices and other factors), the banks are
negatively impacted, we will act decisively to implement appropriate
measures," he said. These comments sounded as if he were just waiting
for an opportunity to use public funds on the banks.

At the time, given such confident assurances by the prime minister and
the financial services minister, and the capital increases being
implemented by the banks, the growing consensus was that there would
be no March crisis. Yet stock prices as measured by the Nikkei 225
slipped through 8,000 and hit 20-year lows.

Normal or Extraordinary Circumstances?
More disturbing, however, is what is going on inside a couple of
select Liberal Democratic Party commissions. As stock prices were
sliding below 8,000, the LDP's financial-policy project team, headed
by Hideyuki Aizawa, rushed to put together a package of
countermeasures to be implemented within the month. While there may be
more than a small degree of hot air being exchanged in these committee
meetings, the import of the LDP's "emergency countermeasure" proposals
is no less than a full-scale attempt to derail all of the "hard-liner"
policies Takenaka has been trying to implement.

The new proposals coming from these LDP committees include:
1. Delay implementation of the law that limits stockholdings of
the banks to within their core capital. Currently effective
from September 2004, the proposal is to postpone this for two
years.
2. Extend the mandatory introduction of impairment accounting for
assets from March 2006 to March 2008.
3. Temporarily suspend market value accounting.
4. Relax restrictions on corporate buybacks.
5. Extend the Equity Purchasing Corp.'s charter by two years.

Aizawa has also suggested a delay of two or three years in the
Financial Revival Program's goal of reducing the ratio of
nonperforming loans for the major banks by half by 2004. And that is
not all; proposed talking points in these meetings also included:
having the Bank of Japan subscribe to bank capital increases; using
public funds for nonperforming loans; using foreign exchange reserves;
having the BOJ widen the scope of its asset purchases from stocks to
ETFs, real estate investment trusts (REITs), "A" ranked corporate
bonds, foreign bonds and other assets; expanding the amount of stock
that the BOJ can purchase from the banks; and expanding the current
ceiling on BOJ purchases of Japanese government bonds. Even if the
Koizumi platform is the "normal mode," the mindset of the LDP at
present is more like an "extraordinary-circumstances" mode. Moreover,
some stock market participants have even gone so far as to suggest a
temporary "market holiday" to ensure that the closing Nikkei average
for the fiscal year at the end of March is above 8,500.

Heretofore, the government had largely blamed the stock market's
problems on the uncertainties regarding the US's impending war on
Iraq, and while this uncertainty has had a negative impact, the
geopolitical implications from increased tensions between North Korea
and the Japan-South Korea-US alliance are potentially more damaging.
Moreover, Japan's stock market only grudgingly responded to the sharp
rally seen in the US market on positive rumors regarding Iraq last
week. It is therefore obvious that the Japanese market problems run
much deeper than the war on Iraq or increased hostilities with North
Korea. Many suggest that if these uncertainties pass, the Japanese
market can see a sharp rally, especially with the onset of the new
fiscal year. But if these external uncertainties pass in a relatively
smooth fashion, and we enter the new fiscal year with the stock market
still under selling pressure, then the situation just might be as
serious as is being indicated by all the Chinese fire drills within
the ruling party at present.

But MoneyWatch remains skeptical about a true "crisis." The real focal
points of all this official hand wringing are:

o The end of the fiscal year on March 31
o Combined regional elections in April

Nothing gets a true dyed-in-the wool LDP politician's blood worked up
as much as the possibility of losing an election. He (or she) will
remain largely impervious to such concerns as a stock market "crisis,"
geopolitical armed conflict or a strong yen as long as none of these
pose a serious threat to the LDP's winning an election. MoneyWatch
suspects that all this sudden concern about the stock market by
old-line LDP politicians is merely crocodile tears for their large
corporate contributors and the voting public, who will go to the polls
in April. Plus, it presents the old line a chance to upset Takenaka's
"hardline" reforms.

-- Darrel Whitten

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Written by Darrel Whitten info@asianbusinesswatch.com

Edited by J@pan Inc staff (editors@japaninc.com)

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