The report and the reaction to it spoke volumes. First, analysts did not have to bother reading between the lines of the BOJ pronouncement, which was unusually straightforward in a culture famed for indirectness. Second, the report did not land as a bombshell, because markets had been expecting it all week. In fact, the view of world markets on the prospect of major, disruptive reform in Japan has shifted 180 degrees since Prime Minister Junichiro Koizumi sacked his “gradualist” FSA chief on Sept. 30 in favor of Takenaka. Now everyone thinks it’s coming. Foreign fund managers have yanked billions of dollars out of Japan, assuming that as Takenaka begins to whittle down Japan’s mountain of bad loans, dozens of huge companies are going to go bankrupt.
Already the impact is being called the “Takenaka Shock.” Some of Japan’s most indebted big companies have seen the value of their stock fall to pocket change (following story), which also undercuts the wealth of banks, who are huge stockholders. “The [BOJ] report was in line with Takenaka’s assertion that something big must happen,” says Hironari Nozaki, senior analyst at HSBC Securities in Tokyo. “The markets are expecting a very severe policy against the banks.”
Takenaka could unveil a batch of tougher regulatory policies as early as this week. Anticipating the shift, the BOJ’s new report suggests stricter lending guidelines and proposes “an option to inject public funds into banks at risk.” The new rules could lead to the nationalization of one or more megabanks as well. “Realistic measures to deal with credit and market risk may leave some major Japanese banks, which are already undercapitalized, practically insolvent,” said the ratings agency Fitch last week. “Fitch is not predicting that all, or indeed any, will necessarily survive in their current form.”
It’s not only global market watchers who expect an early day of reckoning. Ordinary Japanese have lost faith in their banks, too. “Four years ago I withdrew all my savings,” says Yukie Ushijima, a 36-year-old Tokyo housewife. “To me, they’re companies whose job it is to funnel huge loans to big corporations. They are not good at their own business.” Last week, at an invitation-only banking conference sponsored by Merrill Lynch in Tokyo, participants were perturbed when Mizuho president Terunobu Maeda read from a script nose down, with the top of his head facing the audience. “It was the worst presentation in the world, not a single number or target in it,” says one observer. “He didn’t give the impression that he was chairman of the world’s largest bank.”
Mizuho could accurately be described as the mother of all banks. With $1.2 trillion in assets, it is on paper the largest financial institution of its kind on the planet. But it fundamentally differs from companies like Credit Suisse or Citibank. Theoretically, Mizuho is in the business of borrowing money from depositors, then lending it to clients. Profit, in theory, is earned from the spread. But in Japan, the land of zero interest, money moves in strange ways. Households squirrel salaries into savings accounts that offer almost no interest income, while borrowers–mostly big, big companies–pay nearly nothing to get it. “As a result,” concludes a new report by Goldman Sachs, “companies with huge leverage but very little earnings power can still make interest payments. Technically speaking, these still are performing loans.” In practice, if interest payments are so low that even money-losing companies can meet them, the whole system loses profitability and eventually falters–as is happening today with Mizuho and Japan’s other banks.
Japan’s banks have a second basic problem: a shaky foundation of wealth. To operate internationally, banks require a minimum capital-to-asset ratio of 8 percent– meaning $8 held in reserve for every $100 the bank loans out. For Japanese banks, Mizuho included, the bulk of reserves are in the form of tax credits against future earnings (which can’t be exercised unless banks turn a profit) and stocks–which are now slumping badly. “The emperor has been naked for a long time,” says Stephen Church, representative of Analytica Financial Research in Tokyo. His worst-case projection, based on an estimated total of $1.9 trillion in bad loans, is that “capital adequacy for all banks in Japan is minus 25 percent.”
The BOJ’s plan is to begin buying stocks from banks in an effort to lighten their loads. Over the next year it will spend up to $16 billion, but only on stocks in top-rated companies. “No junk,” says Takamasa Yamaoka, director of bank ratings at Standard & Poor’s. The FSA’s new policy task force will announce its own plans as early as this week. The body is expected to call for stricter bank inspections to conclude by the year-end. That, goes the logic, would leave the FSA time to inject public money into weak banks by the end of the fiscal year next March.
Only then will the real work begin. Banks must be forced to pare down bad loans. Those that can’t afford to, as well as companies that lose their credit lines, must be allowed to go bust. “The equity market hates slow change. It especially hates banks trying to keep all the bad companies alive,” says Goldman Sachs in its latest banking report. That’s why most big market players are applauding the Takenaka Shock and the BOJ’s new frankness about Japan’s banking crisis. In the short run, investors are running from what looks likely to be a painful period of upheaval. After that, they see new hope for a Japan healthier than it has been in more than a decade.
