Comment on Mr. Fukui's Proposal for "Radical Surgery" in Japan's Financial System

Richard Werner
(Assistant Professor, Sophia University and Chief Economist, Profit Research Center Ltd., Tokyo)

In his recent piece (11 November 2002), Toshihiko Fukui, the former deputy-governor of the Bank of Japan and contender for the governorship, argued among other points, that in order to revive the Japanese economy, the government should inject tax payers' money into banks and force "bank management to take responsibility for their institutions' financial mess". Mr. Fukui's desire for people to take responsibility is admirable. Unfortunately it is hypocritical. His demand to inject tax payers' money into banks is economically inefficient and creates moral hazard. Most of all, there are far superior ways of solving the bad debt problem.

Economics teaches that in order to avoid moral hazard, those who "mess up should pay up" – a principle that Mr. Fukui seems to agree with in his demand that responsibility be taken. We therefore need to inquire just how the banks' "mess", as he calls it, came about. We all know that banks lent too much in the 1980s, thus creating the bubble, the bad debts and the main cause for the long recession. The key question is, however, just why did banks lend so much at the time? Scientific research has uncovered that the banks were under strict (but clandestine) orders to sharply increase their lending to real estate speculators during the late 1980s¹. The orders were given by the Bank of Japan and meted out by the director of its banking department – during the crucial years from 1986 to 1989 none other than Mr. Toshihiko Fukui himself. Has he ever taken responsibility for his actions, or even bothered to explain them to the public?

Since tax payers did not create the problem, but Mr. Fukui and his Bank of Japan, economics teaches that the central bank should be the one to pay for any clean-up. This is in any case the most efficient method: The central bank should be required to purchase all bad debts from banks at face value, and pay with newly created money. This way, overnight Japanese banks would become the strongest in the world. The costs to tax payers and society at large would be nil. Even the Bank of Japan would make a tidy profit (since it does not cost it anything to create money, while the loans would have some residual value). Indeed, this is what happened after 1945, when the bad debt problem was much larger. The policy, combined with central bank credit creation, was so successful that strong economic growth quickly pushed the economy towards its potential growth rate.

If the solution is so simple, then the next question is why the Bank of Japan has not taken it so far? Instead, for over a decade it has sabotaged sincere efforts by the government to create a recovery. More recently it has been demanding that the government force banks into bankruptcy, then inject our tax money to nationalize the banks in order to foreclose on the large-scale borrowers, thus creating even more unemployment. It is a mysterious policy package, because economically speaking it is the most inefficient and damaging way to go about things. Are the 200,000 bankruptcies of the past decade not enough? Perhaps there would not just be losers: Mr. Takenaka and his leading project team member Takeshi Kimura (a BoJ-amakudari) have been keen to bankrupt dozens of firms who they refer to in derogatory fashion as ‘zombie companies' or ‘dirty thirty' firms. It is surprising to find many firms on this list that have accomplished the feat of maintaining profits despite the severe, BoJ-created slump. So why bankrupt them? Could the desire to sell them at fire-sale prices to US vulture funds have anything to do with it? Is there not a conflict of interest, if Mr. Kimura is also the proprietor of a private advisory business that earns substantial fees from advising foreign investors interested in Japanese ‘distressed assets'? There seems to be a need to state the obvious fact that it is the duty of officials, as well as the Bank of Japan, to work first and foremost in the interest of the domestic general public, and not for foreign financial interests.

Mr. Fukui calls for "radical surgery". Every surgeon will agree that if the scalpel is applied, it should focus on eliminating the diseased parts, while healthy limbs should not be touched. An objective study of Japan's disease cannot but point to the excessive powers of an un-transparent central bank which has created both bubble and subsequent recession and thus has consistently worked against national interests as the very tumor that needs to be removed. If radical surgery is called for, it is the Bank of Japan and its former as well as current staff that should submit to it.

1 Richard A. Werner, Monetary Policy Implementation in Japan: What they say versus what they do, Asian Economic Journal, vol. 16, no. 2, pp. 111-151; see also: Richard A. Werner, Princes of the Yen, forthcoming February 2003.