The economic woes of Japan are the result of an economy drifting without an original idea for almost ten years. Every economic indicator in Japan is pointing the wrong way because the mechanisms of the country's financial sector have effectively seized up. Successive administrations have tried and failed to treat the symptoms without addressing the root cause of this seizure, which is mountainous debt.
The figures involved are mind-boggling. Depending on whose assessment one accepts, the debts companies owe banks and other companies and which banks owe to other banks, range from $375 billion to a staggering $1,500 billion. This means effectively that many banks and companies are bust. They continue to trade because, as long as they do not take the full value of their debts onto their balance sheets, they remain solvent. There have been bankruptcies aplenty already but the idea of the greater part of the business community going to the wall is unthinkable.
Banks continue to clock up interest on loans that they dare not admit have gone irredeemably bad. Problems of similar complexity, if not magnitude, have been solved elsewhere in recent history. Eastern European countries emerged from Soviet rule with state banking systems saddled with nonperforming loans, which they had been obliged to extend to state companies. In addition, companies had supplied each other with goods and rarely settled their debts.
The arrival of free markets left these countries with serious problems. How could a bust financial system and technically insolvent companies function? The solution, which varied from country to country, was generally similar. The Hungarian experience perhaps illustrates it best. International accountants moved in an analyzed bank and corporate balance sheets. They embarked upon a program of netting out intercorporate debts, sometimes going back years. It had the effect of restoring confidence and allowing the companies to climb out from, what seemed on paper to be, crippling liabilities.
The banking system, however, presented the greatest problem. Banks need capital to function and Hungarian banks had nothing except a pile of nonperforming debt. Any new shareholder money put into a Hungarian bank would immediately have been consumed by the bad debt. Therefore, the authorities created what came to be known as The Dead Bank Bank, to which most of the bad debts within the financial system were transferred. The Dead Bank Bank had issued government-backed bonds which gave lenders a long-term chance of retrieving some of their funds. But in the meantime, stripped of their bad-debt portfolios, their balance sheets were restored to health and they were able to attract fresh capital and management know-how, by privatization to local and foreign investors.
Such a solution in Japan also would still depend upon key banking and corporate players owning up to the full extent of their exposure and seizing this once-only opportunity for a fresh start. Maybe outside auditors are the only people with the forensic approach necessary to carry out this surgery. Those institutions which refuse the chance should be allowed to go bankrupt.
