Swimming in Debt

Politician Shintaro Ishihara likes to portray himself as a friend of the common man. Certainly he's no friend of Japan's sinking banks. Last week, the outspoken governor of Tokyo jolted the financial community by threatening to withdraw $14.4 billion of the Tokyo government's money from Mizuho Bank, one of Japan's largest. If Mizuho, which is burdened with $19.4 billion in bad debt, does not clean up its act, Ishihara warned, he'll take his business elsewhere, even to U.S.-based Citigroup. "One thing we must consider is whether a financial institution is safe," Ishihara says. "Another is whether it pays good interest rates. In that respect, there are obviously problems at Mizuho."

The woes of Japan's banking sector have been painfully obvious for years. But Ishihara's public vote of no confidence served notice that, after a brief period of relative calm, the financial system of the world's second largest economy has slipped back into crisis mode. Days earlier, the government released economic growth data that indicated recovery is even farther off than expected, thanks in part to economic weakness in the U.S., a key export market. Of more immediate concern: a sharp stock market decline—fueled by plunging bank stocks—sent the Nikkei average to its lowest level in 19 years on Sept. 3. That's a big problem for the banks, because they hold mountains of shares in Japanese firms. As their value evaporates, so do bank assets, ultimately threatening solvency. According to Brett Hemsley of Fitch Ratings in Tokyo, if stocks drop about another 11%, the shakiest institutions will risk breaching a key requirement for how much capital they need to maintain.

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If this feels like dEja vu, it should. The last banking scare arose only in March. Then, a brief uptick in stock prices allowed banks to report better than expected financial results. But the worries have returned with the recent souring of the global economy. The bank sector's bad loans have increased relentlessly, growing 64% to $302 billion between March 1997 and September 2001. Despite its promises to overhaul the financial system, and hints last week of another economy-boosting package, the administration of Prime Minister Junichiro Koizumi has done nothing substantive to alleviate the problem. Just last week, the Financial Services Agency backpedaled on needed reforms by promising to maintain guarantees on certain bank deposits. Reformers argue that lifting blanket guarantees would force weak banks to shape up or close.

Instead, the weak get weaker, and hope is fading that relief will come from an economic rebound. Government economists on Aug. 30 estimated that the country generated zero GDP growth in the first quarter, revising an earlier estimate of a 1.4% gain. Ken Courtis, vice chairman of Goldman Sachs Asia, predicts no growth at all in calendar year 2002. "The only way to be optimistic about the Japanese economy," he says, "is to turn the charts upside down."

One danger is that Ishihara—who hopes to succeed Koizumi as Prime Minister—might spark a wider loss of confidence in Japan's banks, scaring regular Japanese depositors into withdrawing their money in droves. That could have major repercussions for global stock and currency markets. "It is wrong to underestimate the severity of the Japanese financial crisis," warns Goldman's Courtis.

Bankers themselves aren't inspiring much faith. Mizuho—the product of a merger between Fuji Bank, Industrial Bank of Japan and Dai-Ichi Kangyo Bank—only opened its doors in April. It was immediately beset by problems when thousands of Mizuho customers using ATMs to wire cash found that tthe money had been deducted twice from their accounts. Then Japanese utilities sued after Mizuho's computers botched standing orders to pay monthly electricity, phone and gas bills. Because Mizuho handles the Tokyo city government's payroll and tax collection, Ishihara dispatched inspectors to examine the bank's books and management. He has refused to discuss the city's findings. But the Tokyo government withdrew $2.5 billion from the bank in April, lending credence to his threat to yank more money in months to come. "The government is applying great pressure on Ishihara not to penalize Mizuho," says Hideyasu Ban, who follows Japanese banks for Morgan Stanley. "But nobody knows what he will do."

For now, Ishihara is holding his fire. "I gave (the bank's officials) a list of conditions to meet," he says. "Based on whether they meet those, I have to reconsider the city's ties to Mizuho." It is tempting to assume Japan's banks will somehow muddle through once again. Still, it is hard to exaggerate their talent for shooting themselves in the foot.