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Part 2: Uncharted territory: Bubble to
bust
By Richard Hanson
 Part 1:
Learning by doing
 TOKYO - Try to imagine the
start of a national economic bad dream. It has been more
than a decade since a bewildered Japan plunged into a
historic collapse of prices. We now know this as the
bursting of a greedy bubble of easy-gotten and often
filthy lucre that grew larger than reality could bear in
the late 1980s.
The US Federal Reserve Board
(FRB) of Governors published a report in June titled
"Preventing Deflation: Lessons from Japan's Experience
in the 1990s" that suggests Japan's monetary authorities
had a window of opportunity to nip deflation in the
budding stages.
An FRB model calculates that the
Bank of Japan (BOJ), which cut interest rates to counter
a recession, might ("could indeed", to quote) have
avoided deflation by pushing rates down any time between
1991 and early 1995 by a further 200 basis points.
Loosening after the second quarter of 1995 would not
have done the trick. Inflation had already fallen below
zero.
Virtually zero interest rates became the
cost of money lent by BOJ to banks starting in March
2001 in a novel - in the annals of modern central
banking - way to fight a deflationary spiral. A spiral
suggests "out of control". To move interest rates by 200
basis down points would have meant dropping lending
rates say from 4 percent to 2 percent (100 basis points
equals 1 percent on a bond yield).
Bank of Japan
officials take such modeling with a grain of salt,
despite the Fed report's exoneration that "policy makers
in the early 1990s were not sure what would happen"
whatever they did at the time. There are no certainties
in a market. BOJ deputy governor Yutaka Yamaguchi says
that Japan's zero-rate anti-deflation decision was a
matter of "learning by doing".
A look back at my
notes from the late 1980s and early 1990s may be useful
if only to put some flesh on the dilemma policy makers
faced. Some of the names have changed, victims of the
past decade.
The fall
At the start of
1990, small waves of unsettling news began to wash over
the Tokyo market, as if some distant storm were brewing
somewhere beyond the horizon.
Interest rates
were rising. The yen was weak, which discouraged foreign
buying of Japanese shares. And, if truth be told, maybe
the market had pushed prices a bit too far toward the
end of 1989.
But if the Tokyo stock market was
experiencing a slight New Year's hangover, no one
appeared seriously worried. The doomsayers had been
shown to be wrong more than once about the Tokyo
market's resilience. If investors wanted assurance, they
could readily find it in the media, domestic and
overseas.
Typical was a New York Times dispatch
from Tokyo at the start of the new year, which reflected
the residual optimism of the 1980s. In early January,
the newspaper confidently told readers that "the Tokyo
stock market is increasingly going its own stable way".
"Today Tokyo, not New York, is more and more
being looked upon as a possible model of how a stock
market should be run, a dramatic conceptual shift that
underscores the importance financial experts are
starting to place on stability for fostering economic
health ... Perhaps the most telling statement one can
make about the powerful Japanese stock market is noting
what did not happen here in the last few years: the
Tokyo Stock Exchange did not crash along with Wall
Street in October 1987 and barely budged last October
[1989], when the markets went into a tailspin ... The
total value of Tokyo stocks has, since 1988, exceeded
the value of shares listed on the New York Stock
Exchange. This boom has reflected a remarkable surge in
the Japanese economy over the past five years, which
some are beginning to call the second economic miracle."
So it was easy to dispel doubts about the
future. The past few years had provided one hell of a
ride. Late in 1989, trading in index-linked stock
futures had helped push the Nikkei-225 to a record high
of 38,915.87, a hefty 29 percent jump for the full year.
From the end of 1985, stock prices doubled in value to
the time of the October 1987 crash; at the end of 1989,
prices had tripled in four years. In two years since the
Black Monday shock, however, the nature of the market
had changed with the introduction of full-blown futures
trading based on the Nikkei-225 index listed on the
Osaka Securities Exchange, and in Singapore's Simex.
There was also a less-traded futures cousin, based on
the Tokyo Stock Exchange index, known as Topix. All in
all, futures added a new dimension, and an interesting
subplot, in the market drama that was about to unfold.
Like Janus, the two-faced Roman god for whom the Western
calendar's first month is named, they accelerated both
the inflation and the deflation of the bubble.
On Thursday, January 4, 1990, the first day of
trading, stock prices were down. The next day, during an
otherwise uneventful Friday afternoon session, the
market was suddenly hit by disturbing news. The wire
services flashed reports that Soviet leader Mikhail
Gorbachev might be in trouble as a result of domestic
unrest. Hopes of stronger ties with the West might be
jeopardized. The Nikkei-225 lost 1.1 percent of its
value. A large part of the drop could be traced to
foreign brokers trying to make money as gaps opened
between the price of stock-market index futures and the
actual level of the market, a form of arbitrage that
required sophisticated computer programs.
For
Tokyo, that was an ominous sign. Arbitrage operations
had supported prices in the last leg up of the 1989
market. As the days passed, prices were further buffeted
by falling bond prices. Making matters worse, the market
was rife with rumors that another domestic political
scandal involving stock-price chicanery lurked
threatened to erupt as a general election in February
drew nearer.
By mid-January, the steady erosion
of prices alarmed some brokers. "It's impossible to give
an outlook for a bottom level," said Kazuyuki Ohata, a
senior analyst at Nippon Kangyo Kakumaru Securities Co
after a 1.7 percent drop on Friday, January 14, and a
further 1.8 percent decline in the Nikkei index the
following Monday. A senior Bank of Japan official told
reporters that perhaps the central bank had not fully
assessed the impact of interest rate hikes on the stock
market.
In hindsight, this is when the
stock-market bubble began to collapse. Like other market
implosions, influenced by investor mood swings, there
would be plenty of volatility on the way down.
There was to be a lot finger-pointing as the
collapse of stock prices led to the collapse of the
value of property and other assets. Golf-club
memberships were the most symbolic lessons in the danger
of believing that wealth can be created out of hitting a
small ball with a club.
Much of the focus of the
action centered on the Ministry of Finance (MOF), which
ruled over all financial market (except commodities and
consumer credit) before it was defrocked in the late
1990s. That was when the name was changed from Okurasho
to Zaimusho and the Financial Services Agency (FSA) was
stitched together to control financial market policy
making and supervision.
There are too many
aspects to recount here. One is how the regulators saw
themselves.
Don't explain
A senior MOF
official in an off-the-record drinks party arranged by a
major Japanese bank for senior members of the bank's
staff and a smattering of financial analysts and foreign
journalists once gave a startlingly candid response to a
question about why the Ministry of Finance didn't state
its opinions more clearly in public.
"We never
explain our policies, until we are asked. In order to
get a correct view of our policy, you have to ask the
right person in charge. I think that is still the
policy." It was reminiscent of the response to a
financial journalist's query by a spokesman for the Bank
of England during a European monetary crisis: "No
comment, and that is off the record."
Within the
Finance Ministry, it is standard procedure to avoid
reacting to stories in the media, even if they are
outrageously speculative or just plain wrong, unless
queried. While MOF officials are as thick as thieves
with some journalists, they can be equally cool to what
might be considered their natural allies in the press.
Nihon Keizai Shimbun, for example, has about 20
reporters assigned to cover the MOF through the
ministry's press club, the Kinyu Zaisei Kenkyu-kai, on
the second floor of the ministry's headquarters
building. Yet it has a reputation within the MOF for
getting stories wrong. This is attributable mainly to a
reluctance on the part of many MOF officials to trust
Nihon Keizai to get the story right. Under pressure to
produce scoops, Nihon Keizai reporters and their desk
editors at times stretch the margins of accuracy. One of
the many chores of working as a foreign correspondent in
Tokyo was to wake up each Monday morning to Nihon
Keizai, which in the absence of hard news became
notorious for contriving big headlines. (At a more
serious level, the newspaper's credibility was strained
greatly when in 1988 a sister publication of the rival
Asahi Shimbun first revealed that an especially
ambitious president of Nihon Keizai was among the list
of prominent politicians, bureaucrats and businessmen
who accepted the get-rich-quick pre-listing shares
offered by Recruit.)
A cult of secrecy pervades
the corridors of the MOF, despite the usual openness of
individual MOF officials, who normally agree to talk as
long as they are not identified in stories. The Japanese
press has unwritten rules, if followed, when referring
to senior officials in a sort of code that allows the
careful reader to judge just who is saying what. But
what the public and press see of the inner workings of
the ministry often has a looking-glass quality to it.
Competing banks and brokers hide behind the veil of real
or supposed MOF guidance in justifying their
self-interests. Quite often the MOF's reluctance to
enunciate policies clearly is a self-defense mechanism.
In the West, this stratagem has long been castigated as
a lack of "transparency", and a barrier to doing
business in Japan. In Japan, it is more often considered
as the best way to do business.
Historically,
the "don't explain" mentality has sometimes served a
useful purpose. For example, the MOF, with the consent
of the Occupation authorities, in February 1946 imposed
a sudden freeze on all bank accounts and ordered the
conversion of the old currency into "new yen". MOF
officials, however, never quite explained why they were
taking such drastic steps. Certain assumptions about
fighting inflation and preparing for a new assets tax
were made. Internal ministry documents suggest that the
measures, in addition seeking to stabilize monetary
conditions, were prompted by the very real specter of
running out of hoarded food stocks and consequent
starvation. But the MOF couldn't very well have
announced that the country was about to starve as a
reason for freezing bank accounts (separate measures
were taken on the problem of hoarded food).
Similarly, though certainly less critical, is it
better to announce that the finance minister's temper
got the best of him, or live with press reports
speculating over a rift between the BOJ and the MOF over
the discount rate hike? The impression of a rift over
policy continued to distort press reports in the early
months of 1990. Nominally, the MOF's policy is to let
the policy speak for itself. At times, markets simply
don't pay enough attention.
By January 1990, a
senior official in the MOF made it clear that the
consensus among the ministry's senior bureau chiefs was
that, "reluctantly", a further tightening of credit
would be needed, even if it meant higher interest rates
on government bonds. The BOJ argued persuasively that
the danger of inflation in asset prices - stocks and
property - could spill over to the real economy, whereas
inflation on the wholesale and retail level was not yet
an obvious problem. There were deeper concerns over the
social impact of the sudden bubble of wealth spreading
through the propertied class, which in some form
comprises about two-thirds of Japanese households. Would
the work ethic suffer?
"Has the battle for zero
land-price increases begun?" wrote one commentator in
late January 1990. That seemed at least a distant goal,
given ongoing speculative prices rises in regional
centers. One question was whether a soft landing for
prices could be achieved without driving stock and bond
prices into frenzy. A more basic one is whether tight
money would dampen speculation on land prices. In 1990,
the jury was still out.
In early 1990, the Bank
of Japan experimentally applied a price model developed
by the US Federal Reserve, known as P*, in calculating
the underlying threat of inflation. The central bank
found that land-price inflation was already spilling
over sporadically into wholesale and retail inflation.
Theoretically, land prices don't cause inflation
in the economy, BOJ officials agreed. But in Japan's
case, land prices rose mainly as a consequence of policy
distortions, namely land-use laws and taxes. They
reckoned that about half the rise in real-estate prices
in the latter half of the 1980s was due to the low
interest rates maintained by the BOJ until May 1989. By
no stretch of the imagination did land prices reflect
economic conditions, except possibly in central Tokyo.
Rents simply could not rise fast enough to justify the
price increases.
The BOJ's 1990 calculations
were almost clairvoyant. They estimated that it would
take at least half a decade for the real economy to
catch up with the level of land prices, or roughly the
term that BOJ governor Yasushi Mieno would serve in
office. But no one imagined that the land bubble would
burst as quickly as it did, nor that the economy would
enter its longest postwar slump.
The 1990s was a
period in which a horrendous number of surprises burst
on to Japan's economic and political screens. They did
not float to the surface. They were exposed by
fast-draining swampy bubble-era pools. It is amazing
what ill-gotten gains of corruption - good old-fashioned
corruption, not to mention high-tech things - would
never have been noticed if prices had risen for ever.
It is best to call to call them what they were.
Scandals
By early summer 1991, there
was trouble at the core of Japan's financial industry.
It was as if some virus had attached itself, and struck
almost randomly in the most unexpected quarters. The
catalyst was none other than the collapse of asset
prices - stocks and real estate - as the economic bubble
of the late 1980s deflated.
More disturbing was
undeniable evidence that segments of normal Japanese
society - the establishment - were closely linked with
the underworld, whose presence had always been
acknowledged but usually with knowing winks and nods.
The relationship became furtive on society's side, like
infidelity with a prostitute, until the lovers were
caught in the act. A year before, two property
developers with shady connections were found to be
drawing off funds from Itoman & Co, an Osaka trading
house closely affiliated with Sumitomo Bank, one of the
Japan's top "city" banks. The top officers of both
institutions were revealed as venal and irresponsible at
best, and linked to the underworld at worst. Itoman
eventually disappeared, while Sumitomo sorted through a
colossal pile of debt left in its wake.
In late
May 1991, one of the top three officials at the Bank of
Japan, identifiable only as a "senior official", warned
reporters that "yakuza elements are getting
stronger ... are creeping into certain normal elements
of society, but we don't know to what extent". Evidence
soon surfaced.
One of the first shocks came on
May 29, 1991, in a story published on the front page of
the afternoon edition of the Yomiuri Shimbun, Japan
largest daily newspaper with a national circulation of
nearly 10 million. The story revealed that between April
and November 1989 the notorious Susumu Ishii, a
brilliant former chairman of one of Japan's largest
organized crime gangs, the Inagawa-kai, accumulated more
than 23 million shares in Tokyu Corp, a giant private
railway, property developer and retailer. Ishii did his
trading through the good offices of Nomura Securities
and Nikko Securities, two of the top "Big Four" brokers
in Japan. The most shocking revelation, perhaps, was
that Ishii cleverly used the Tokyu shares themselves as
collateral to borrow 36 billion yen (US$304.7 million at
today's rates) from two financial subsidiaries, Nomura
Finance and Nikko Credit, after he was introduced as a
customer by officers from the parent companies. The
finance-company loan officers realized that Ishii was
not an ordinary customer when they visited his
headquarters, but nonetheless extended the financing.
(Yakuza headquarters are noted for the presence
of many idle-appearing men with permed hair, tattoos and
missing finger segments, which they have cut off to show
loyalty to their oyabun, or master.) A customer
was a customer, and competition to build up assets was
fierce.
Three weeks later, on June 20, the
Yomiuri again scooped its competitors with a story that
claimed that Nomura Securities had compensated large
clients for securities losses to the tune of 16 billion
yen from the beginning of 1990, when Tokyo share prices
began a precipitous fall. This marked the first time
Nomura had been tarred with the compensation brush.
On the following day, on June 21, 1991, the
Asahi Shimbun splashed a front-page story graphically
displaying just how intimate the ties between the
underworld and respectable financial circles had grown.
A collective chill rippled down the spine of respectable
Japanese society. The yakuza had deep historic
roots in Japan. They quickly became a part of the modern
social fabric after the Meiji Restoration in 1868,
operating on the fringes of Japan's increasingly urban
society. They were now learning the tricks of the
sobashi, the disreputable speculators who had
evolved into Japan's securities industry brokers.
The Asahi reported that the world's largest
securities house, Nomura, and Japan's third-ranked
broker, Nikko, were directly involved in financing
Ishii's activities dating back at least to 1986. To
officials in the Finance Ministry, the brokers had
crossed the fine line between legitimate business and
the dark underbelly of Japan. As the wave of speculation
in stocks and property swept through Japan in the 1980s,
the line between legitimate and criminal activities had
in fact blurred.
Criminals found it just as easy
to make money legitimately as from their more
traditional underworld trade, such as prostitution and
drugs. They were only slightly less scrupulous than
other bankers, real-estate developers and stock
speculators, who often sought out the services of
yakuza to handle the delicate business of debt
collection or intimidation. The gangs had risen from the
ranks of pesky sokaiya, who blackmailed companies
to prevent disruptions at annual shareholder meetings,
to the status of customers.
Through their
finance affiliates both Nomura and Nikko bought 2
billion yen each in membership receipt certificates in a
golf-course project controlled by the gangster Ishii.
These certificates were worth about as much as the paper
they were printed on. As the Yomiuri had reported
earlier, Nomura Finance lent Ishii 16 billion yen and
Nikko Credit lent 20 billion yen on the security of
shares in Tokyu Corp. Nomura was soon implicated in an
earlier scheme to manipulate Tokyu shares, allegations
that the Finance Ministry and the police investigated.
Criminal charges were never brought up, but Nomura was
later hit with stiff administrative punishment for its
central role in the affair, which included organized
buying to push prices up through its large branch
network.
Nomura's disgrace was complete. A year
before, it had launched a libel suit against a book
published in London called the House of Nomura, by an
author who had worked in Tokyo for the British broker
James Capel & Co. He recounted often-heard rumors in
the Tokyo market of "black money" profits from
speculative stock and real-estate groups with underworld
ties pouring funds back into the stock market, which at
times had constituted 10 percent of Japanese trading
volume. Nomura's alleged ties with yakuza
customers included a gruesome tale of a branch manager
being beaten into a fatal coma by a thug upset over
losses on a stock play recommended by Nomura. Imagine
the shock when it turned out large chunks of alleged
black money were actually loans from legitimate finance
companies, backed by the best of Japan's banks and the
brokers. Nomura later dropped the libel suit.
The most unsettling news was that now virtually
all of the big Japanese securities houses were publicly
implicated in the scandal involving secret compensation
payments for securities losses to favored clients. Those
allegations, however, paled in "moral" terms compared
with revelations about links to the ungura, as
the underworld is called in Japanese. Compensation and
price manipulation made a mockery of Tokyo's claims of
market fairness. The gangster revelations were serious
enough to force the sudden resignations of the
presidents of Nomura and Nikko, while chief executives
at the other Big Four brokers, without direct gang
links, kept their jobs, at least for a while longer.
Other segments of the financial community
watched with trepidation. Yoh Kurosawa, the popular
president of the influential Industrial Bank of Japan
(Nihon Kogyo Ginko), temporized to a foreign journalist
that "the misfortune of my neighbor is my own
misfortune. This is bad for all of us." Before the
summer of 1991 was over, his words resonated hauntingly
as some of the biggest banks in Japan, including his
own, were caught in a seemingly endless swirl of fraud,
poor management and feckless regulation by the
authorities in the Finance Ministry.
The
problems exposed by the collapse of stock prices and the
pricking of the real-estate price bubble shook bankers
and brokers to their core. More important, the
continuous reports of favoritism and rigged markets
helped drive investors away from the market. With
investor confidence shattered, the stock market entered
what would become the most prolonged slump in its
history.
A sense of disbelief prevailed in those
days. How could Japan's financial markets have risen to
such heights, and plunged to such depths in so short a
time?
Back to the Japan of July 2002, which is
being pounded by one of those "very strong" typhoons
that manage to barrel their way at the heartland on the
main island of Honshu.
At the moment, the
government of Prime Minister Junichiro Koizumi is
swirling in the eye of a political storm over the
policies that he has fought for (or let fall by the
wayside) during his first year in office. The key
policies will decide the direction that reform will
take. Many are vital for the long-term interests of the
country. Others will help decide how long he might stay
in the Prime Minister's Office.
Koizumi has been
confronted with a fair share of scandals and political
gaffes in his time in office so far. None seems to have
dampened his ardor. The realities of compromise in
politics have taken their toll.
Economic policy
and closely related reforms of how government operates
are at the heart of the agenda in the extended Diet
(parliament) session that closes on July 31. The issue
of deflation is very much on the minds of politicians
and policy makers. There are no fewer than three
deflation-related bills on the table.
Key
ministries and new agencies have arisen or been
transformed during the years following the collapse of
the bubble economy. The bureaucracy, however, is nothing
if resilient. So when Koizumi tilts at the winds
opposing change and reform he will depend heavily on the
bureaucrats whom many blame in part for not preventing
the problems of deflation, out-of-control bad bank
loans, and barely manageable government debt. These are
the beasts that Prime Minister Koizumi will stalk.
Next: Stalking the beast: Koizumi tilts at
windmills
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