Treasury Secretary Robert E. Rubin discusses the Asian financial crisis at the White House. (AP)

By Clay Chandler and Sandra Sugawara
Washington Post Staff Writers
Thursday, June 18, 1998; Page E01

Japanese leaders promised yesterday to fix their ailing banking system, but they stopped short of saying they would undertake the drastic measures urged by the U.S Treasury and many international financial experts.

Treasury Secretary Robert E. Rubin and his top aides have pleaded with Japanese officials to employ the sort of ruthless, market-oriented policies that helped the United States bounce back from the savings and loan crisis of the 1980s: Close failing banks, merge the weak with the strong, and force the survivors to accept huge losses.

That approach worked in the United States over six years and at a final cost to the taxpayers of about $100 billion, but without inflicting broad suffering or social dislocation.

Sounds easy.

But many private analysts, including skeptics and advocates of such steps, warn that the Japanese would have a far harder time. Japanese officials face a problem with bad loans -- debts to banks that are not being repaid -- that is roughly six times as large relative to the size of their economy and spread more widely through the banking system. They also struggle with structural, legal and cultural obstacles that likely would make the process -- even if successful -- more lengthy and painful.

"Japan's bank problems are huge -- significantly bigger than what we faced in the United States," warned J.P. Morgan & Co. executive T. Timothy Ryan, who served on the U.S. government's Resolution Trust Corp. from 1990 to 1993 and now spends much of his time advising Japanese clients on how to learn from the U.S. example.

"I think a lot of the U.S. strategies may be transferable to Japan, but it won't be easy," Ryan says. "And a lot of the solutions that helped us aren't available in Japan."

The stakes also loom large. If done right, curing the Japanese banking system could spur that economy out of recession and help pull the rest of Asia out of financial turmoil. But if it is done ineptly, the sick banking system could prolong Japan's recession and trigger a global financial crisis.

To grasp the staggering dimensions of the Japanese banking problems, it helps to do some basic math.

From 1989 to 1995, the RTC closed 747 U.S. thrift institutions, nearly half of them in the first six months, and sold off about $465 billion in assets, including 120,000 real estate properties, at a net cost of about $100 billion.

But the S&L crisis seems modest compared with bank troubles in Japan. Consider:

Japanese bad loans are estimated to be worth at least $600 billion, about half of which are probably worthless. But Japan's economy is about half that of the United States. So, by implication, Japan's bad-loan problem, relative to the size of its economy, is about six times as large.

Bad loans pervade the balance sheets of virtually all of Japan's banks. That means even if assets of broke or struggling banks were auctioned off, few strong lenders stand ready to act as buyers. In the United States, by contrast, bad loans afflicted a relatively small portion of lenders concentrated in a handful of major states.

Sick banks matter much more in Japan than in the United States, because Japan's stock and corporate bond markets are less developed, and so are a far smaller source of capital for the private sector. Thus, when the banking system falters, Japanese companies have few alternative sources of money.

The cost of bad loans Japan's banking crisis is much larger than the U.S. savings and loan debacle. U.S. savings and loan crisis cleanup $100 billion Japan's unrecoverable bank loans $300 billion What's eating at Japanese banks Bad loans: While they afflicted a relatively small number of thrifts during the U.S. crisis, bad loans are a problem for almost all of Japan's banks. Shortage of buyers: There are almost no healthy banks to acquire the assets of cash-strapped banks. Dependence on banks: Japanese people have few alternative sources of obtaining capital because their stock and corporate bond markets are less developed.

The end result is that capital, the lifeblood of the economy, is circulating much more slowly. The weak banks can't make new loans to firms, so fewer firms invest and the economy shrinks. Moreover, the original borrowers find it all the more difficult to repay their debts.

In the United States, the RTC, working with the Federal Deposit Insurance Corporation, helped break this vicious cycle. The FDIC determined which lenders should be forced to close. The RTC then took over the books of the failed institutions, paid off their creditors and attempted to resell their assets as quickly as possible. In other words, they foreclosed on and then sold the properties and other assets pledged as collateral for the loans.

The RTC's job was made easier by the fact that it accumulated property from many different thrifts and could repackage those assets in ways that would make them more attractive to potential buyers. Office buildings in several locations, for example, could be assembled into a single portfolio for resale.

So far, Japan has resisted this type of solution. Earlier this year, the Japanese legislature set aside $219 billion for shoring up weak banks. The money can be used to protect depositors, purchase stocks of struggling lenders and buy the assets of distressed lenders. But they have spent only a tiny fraction -- $13 billion -- so far.

On Monday, Japan is to establish a new Financial Supervisory Agency, which will be empowered to shut down a bank if its liabilities exceed its assets, but will not be required to do so. By comparison, U.S. bank supervisors must take some action, including possibly closing a bank if its capital ratio -- the bank's net worth relative to its assets -- falls below 2 percent.

Prime Minister Ryutaro Hashimoto said yesterday that Japan "will make every effort to restore its banking system to health," and Finance Minister Hikaru Matsunaga detailed steps such as disposing of bad loans more aggressively, restructuring financial institutions, improving disclosure of banks' financial information and strengthening banking supervision.

But neither official mentioned the possibility of closing banks. Hashimoto has called for an emergency "bad bank" session of the Japanese parliament late next month to push through a package of measures that would streamline government-run property auctions and grant more favorable tax treatment to banks writing off bad loans.

But those measures won't change one fundamental obstacle to getting bad loans off the Japanese banks' books -- namely, the shortage of healthy banks with the money to buy the assets of cash-strapped banks.

"What's different about Japan right now is that, as a practical matter, there are almost no healthy bank buyers there," said Robert Litan, a banking expert at the Brookings Institution in Washington. "This is mind-boggling."

Other potential buyers include foreign investors, including representatives from Goldman Sachs & Co., J.P. Morgan Asset Management and other U.S. asset managers. Many have already bought such assets, and some U.S. investors say the pace of these deals quickened in recent weeks as the economic crisis grew more dire. Several U.S. investors have complained, however, that some of the assets for sale have been pledged as collateral for multiple loans -- a common practice in Japan -- and the Japanese lack an effective legal system for sorting out competing claims.

Another obstacle has been the government's reluctance to inflict the bitter medicine of bank closures, and doubts about whether it would work.

Leaders of the ruling Liberal Democratic Party are loath to force closures before an upper house election scheduled for July 12. Widespread failures would hammer not only the banks but also property development companies and construction firms, which are among the party's most generous contributors.

And many Japanese leaders question whether closing banks would really help the economy. Many point to hardships in Hokkaido, Japan's northernmost province, after last month's closure of the area's most important lender, Hokkaido-Takushoku Bank Ltd. No major lender has stepped in to look for lending opportunities in the region, and the Hokkaido economy is languishing.

After a burst of spectacular bankruptcies late last year, some Japanese officials declared emphatically that no more financial institutions would be allowed to fail. But in recent weeks, as investors dumped Japanese stocks and the yen hit an eight-year low against the dollar, Japanese leaders have been urged to rethink that position.

The advice rankles many in Japan. "In Japan, we wonder why the U.S. boom seems to require fresh victims from Asian markets to be sustained," observed Takashi Kiuchi, a senior economist at the Long Term Credit Bank of Japan Ltd.

Many experts who favor an RTC approach in Japan predict it would give a quick boost to the currency and stock markets, but concede that the process would be a long one.

In the long term, "we see a reasonable chance of all this getting worked out," says Richard Medley of Medley Global Advisors, a New York hedge fund. "But even if that happens, we'd expect at least two inherently destabilizing years for the Japanese economy."

For now, however, some Japanese depositors are shifting their savings to Citibank, which one Japanese survey recently found ranked as the second most popular bank in Japan.