The Year Ahead

Back to Contents of Issue: January 2003

Takenaka's bad-loan drama, starring the gatekeeper of Hell, will play out on center stage while the third wave of buyouts lurks in the shadows. The supporting cast includes a jaded generation of young people who are too confortable to get passionate about anything.

by Editors

BAD LOANS LOOM ON the horizon like Mount Fuji. One brokerage, HSBC Securities (Japan), estimates that they equal 15 percent of Japan's gross domestic product. But the figures are numbing. The reality is that tackling these bad loans could result in a surge of bankruptcies, the collapse of one or more of Japan's main banks and soaring unemployment. In a word, solving the bad-loan problem means "pain." And Heizo Takenaka, the minister of economic and fiscal policy, has unleashed a plan that would bring plenty of pain and, he believes, forge a path through that mountain of bad loans.

The government unveiled an anti-deflation package on October 30 that would slash in half the ratio of nonperforming loans held by Japan's 13 major banks by fiscal 2004. On the same day, the Financial Services Agency (FSA), also headed by Takenaka, said it would use stricter standards when evaluating bank loans. This day, more than any other in recent memory, set the tone for 2003.
Although the anti-deflation package "diminished the risk of a hard landing" for the economy, says Yasuhide Yajima, a researcher at Nissei Research Institute, "deflationary pressures such as an increase in bankruptcies and the unemployed are unavoidable."
Yajima calculated several scenarios that may play out this year. If Japan succeeds in disposing of JPY15.4 trillion worth of debts classified by the FSA as "bankruptcies or bankruptcies in the real term," GDP would be pushed downwards by 0.5 percent and the unemployment rate would rise by 0.4 percent. If Japan fails in its attempt, GDP will be pushed downwards by 0.7 percent, and the unemployment rate would rise by 0.7 percent. According to his calculation, at least 650,000 people would leave their jobs in the latter scenario.
What's more troubling to many businesses on the brink of collapse is that they may soon have their fates decided by "the Gatekeeper of Hell." At least, that's what the Japanese media are calling the future chairman of the industrial revitalization agency, because that person would have the final say on whether certain companies live or die.
The public-private agency, to be set up this spring, would focus on loans from borrowers that are to be rehabilitated, Sadakazu Tanigaki, the minister in charge of overseeing the agency reportedly said. Its counterpart, the Resolution and Collection Corp. (RCC), is focused on bad loans from borrowers that are to be liquidated. Thus, the person who decides whether a company's loans are sent to the RCC or to the planned industrial revitalization agency has the power of life or death over a company. This Gatekeeper of Hell should come from the private sector, says Tanigaki, according to reports in the Japanese media.
Will the gatekeeper plan work? Analyst assessments are mixed. Darrel Whitten, author of J@pan Inc's weekly email newsletter MoneyWatch, offers this assessment: "The one flash of hope is that the Koizumi Administration stumbles toward a 'good account,' 'bad account' solution. This solution was used immediately after Japan's defeat in World War II to clear the decks of nonperforming loans by having all the players -- companies, financial institutions, shareholders, corporate depositors and the government -- share the burden.
However, neither Heizo Takenaka nor Junichiro Koizumi are a Douglas MacArthur, who had the luxury of a totalitarian occupation regime to impose such a solution."
Lists of companies on the verge of bankruptcy have been circulating through elite business and political circles for months now, beginning with the so-called "dirty 30" list and more recently followed up by a list of 51 companies widely reported in the Japanese media. But as one financial expert put it, you could give two people copies of the Kaisha Shikoho (the biannual book of financial data from listed companies), send one to the South Pole and another to the North Pole, and both would come back with pretty much the same list.

The government's anti-deflation package also calls for the government to inject more public money into banks if their capital adequacy ratios decline. One point being debated as 2002 came to an end was whether the government should purchase preferred shares, as it did in 1998 and 1999, or whether it should opt for common shares, giving it a vote and a voice in the way the banks are run. If the government elects to buy common shares, it raises the specter of nationalized banks.

Technically, preferred stock -- which does not carry voting rights but is at the front of the line when it comes to collecting dividends or funds from a collapsed company -- can be converted into common stock after a certain period of time. UFJ Holdings, for example, has issued JPY1.4 trillion worth of preferred shares to the government, out of which JPY1.1 trillion is already due for conversion. But no preferred stock bought with public money injections has ever been converted.

Should the government buy common stock in Japan's major banks and make its voice heard when the banks make key management decisions? If it converted preferred shares it already holds, the government would have an average holding of 25 percent in every major bank but Tokyo-Mitsubishi, which has repaid all the public funds it borrowed, according to the Nihon Keizai Shimbun, Japan's leading economic newspaper. With further injections, the paper posits, the government could end up owning one-third of the outstanding shares in some of the banks, giving it veto power in strategic decisions like mergers and acquisitions in shareholders meetings.

But some economists doubt that the government is likely to take control of the nation's banks. "They would probably avoid that as much as they can," says Peter Morgan, chief economist at HSBC Securities (Japan). "They may well buy more shares, but they would probably stop short of nationalization unless it's absolutely necessary."

First of all, the government would have to find a new management team capable of running the nationalized banks. "Where are the new management teams going to come from?" Morgan asks. "Where are all these bankers who have different ways of doing things? There is no other management team available to take them over. It's slightly pointless to nationalize the banks."

Of course, the government could sell the nationalized banks to foreigners, like it did with the former Long Term Credit Bank, bought by US private equity fund Ripplewood Holdings and turned into Shinsei Bank. But Morgan says that option is "politically unacceptable."

"The government really didn't like that experience," he says. "Shinsei Bank is now more of a Western style bank; it doesn't play by the Japanese rules. The government, to a certain extent, regrets that and doesn't really want to repeat that experience."

As the government debates what to do with the banks, private equity funds are quietly debating their next moves. Last year, "buyouts" was a buzzword in Japan, but many in the industry say that the hype preceded the action. This year will be a more active one for buyout funds looking to invest in distressed assets or non-core assets of troubled companies, sources say.

One reason for the activity is that several Japanese funds are up and running. Traditionally, these buyout funds have been foreign players with names like Ripplewood and Lonestar. Early entrants have been in Japan since the late 1990s, buying up troubled golf courses and buildings built in the bubble period of the late 1980s and early 1990s. Industry sources say Lonestar, Cerberus, and Goldman Sachs, among others, have already bought up a major portion of the real estate used as collateral during the bubble era.

Phase two of buyout funds began at the turn of the century as the government sold two troubled banks -- Shinsei and Kansai Sawayaka Bank -- to foreign buyout funds.

In 2003, the industry is poised to accelerate purchases as the government shows signs of getting serious about its nonperforming-loan problem. And this time around, Japanese funds will be part of the picture. For example, Tokyo-based Phoenix Capital has launched two funds this year to "revitalize" Japanese businesses, including a JPY47 billion "Nippon Revival Fund," financed by domestic banks such as Tokyo-Mitsubishi, Sumitomo Mitsui, and several regional banks. In the meantime, Mizuho Securities and NTT DATA, in collaboration with Bain & Copmany Japan, established Japan Industrial Partners Inc in November, to support Japan's "business reorganization, restructuring and reform." Other Japanese funds are emerging as well, although they tend to be smaller than the foreign funds -- domestic funds tend to be tens of billions of yen, while foreign funds are a full digit larger. As the market becomes more crowded, there's a good chance that some of the funds in play now won't be around to ring in 2004.

China's role in the world economy will force change in Japan during 2003, analysts say. "As China becomes the world's factory, there is even less necessity to accumulate capital in high-cost countries like Japan," writes Pascal Nguyen, a managing partner of the Tokyo-based financial services firm WBP, in a memo to J@pan Inc. "However, China's build-up effort requires the kind of capital goods produced in Japan."

Look for Japan's manufacturers to concentrate more this year on high-end production and capital-intensive new technologies such as fuel cells. Also, companies will be reviewing their intellectual property strategies to see if they can sell off dormant patents or pick up patents on the cheap from other companies. Japan will become less of a manufacturing powerhouse and more of a knowledge society during the next 12 months.

Any discussion of Japan's economy would be remiss if it didn't mention the JPY1,400 trillion in savings the Japanese people hold. This is the giant nest egg that soothes Japanese households in the face of media predictions of economic doom and gloom. And it's what gives Japan's economic downturn its peculiar twist -- the world's second largest economy struggles for more than a decade to right itself, but visitors still exclaim at all the money being spent on the streets. "I don't care what you say -- there's a lot of discretionary money out there," says David Matsumoto, a psychology professor at San Francisco State University and the author of The New Japan: Debunking Seven Cultural Stereotypes (see page 4 for a review).

He's right, of course. But then, so are the doomsayers -- at least to a point. That's the conundrum of present day Japan: large macroeconomic problems coupled with individual wealth. Nguyen of WBP says the average Japanese household will have to learn to handle more risk in the near future. "Households have been mostly insulated from financial risk-taking," he writes. "They were also insulated from economic risk-taking given the traditional lifetime-employment system." But that's all about to change, he says, with the JPY10 million insurance cap on bank deposits, expected April 2003. "Households will have to learn to manage their assets."

This is not exactly causing panic in the populace, however. "The average kid on the street is not going to change too much until there's a need to change," says Matsumoto, who lectured at the University of Tokyo in December. "Things are going to kind of be the same as long as they have cash in the pocket."

Cash is not a problem. But dreams are, argues Matsumoto. "Ask a young Japanese kid today what his dreams are, and I'll bet you bottom dollar he doesn't know what to say." He says modern Japan is in the midst of a spiritual and cultural crisis. "Japan has lost itself in the transition of the last 30 or 40 years. It has lost touch with those things that make it singularly unique and wonderful." Matsumoto sees an opportunity for companies amid this spiritual, cultural and economic malaise. "Organizations can look at their roles as educators. Part of their business is to reinforce or create a culture. They could make that aspect of their function equal in importance to making a buck." Companies that pay more attention to their educational role may just be able to stir something inside the directionless youth of Japan, he says.

"There are very bright individuals who are not being tapped," Matsumoto says of recent university graduates. "They have great potential, but you have to foster them." @

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