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August 4, 2008

All that Tax Money Gone, No One to Take the Blame

Supreme Court's acquittal of LTCB execs conjures up old question of who bears responsibility for Japan's post-bubble financial crisis

Masahiko ISHIZUKA (Councilor, Foreign Press Center Japan, and Lecturer, Waseda University)

It was 10 years ago that the Japanese financial system was driven to near collapse, pushed to the brink by the crisis rooted in the crumbling of the bubble economy of the 1980s. In order to save the nation's financial system from breaking down, a vast amount of public funds was infused into banks in danger of disintegrating.

"Moral hazard" was a phrase prominent in headlines in those days, part of a heated debate over whether banks' ethics should be called into question for their allegedly irresponsible behavior during the bubble. The infusion of taxpayers' money to bail out failing banks, it was argued, amounted to acquiescing to their unethical business practices instead of punishing them.

That argument is being echoed in the ongoing American financial crisis, in which the U.S. government might eventually be driven to infuse taxpayers' money into financial institutions like Fannie Mae and Freddie Mac in earnest. The Japanese media appear inclined to call for U.S. authorities to learn a lesson from Japan's experience, whereby the situation was exacerbated by prolonged hesitation against taking definitive action for fear of appearing to condone moral hazard and angering the public. Memories of a Japan coming under U.S. pressure to act more decisively also come to mind.

Japan's post-bubble financial crisis reached its defining moment in 1997, with the successive failures of such big name institutions as the Hokkaido Takushoku Bank, Yamaichi Securities Co. and Sanyo Securities Co.

Long-Term Credit Bank of Japan was one of the failing banks, but it was saved from bankruptcy by means of temporary nationalization in 1998, involving nearly ¥8 trillion ($75.4 billion) in taxpayers' money (of which ¥4.8 trillion was lost). The bank was eventually taken over by a U.S. fund and recreated into Shinsei Bank in 2000.

Amid the charged atmosphere at the time, the government and politicians needed somebody to hold responsible for the banking mess that cost the nation so dearly - not just in terms of public money, but also orderliness and public confidence in the financial system.

As scapegoats, Katsunobu Onogi, then president of the LTCB, and other executives were arrested and indicted by the Tokyo District Public Prosecutors Office - allegedly with the tacit agreement of the Ministry of Finance - in 1999. They were charged with employing fraudulent accounting practices on bad loans to make them look smaller than they actually were - and even paying dividends - for the financial period ended March 1998, refusing to comply with the Finance Ministry's guideline.

Reversal of fortune

They were found guilty by the Tokyo District Court in 2002, and the Tokyo High Court supported the district court's ruling, turning down an appeal in 2005. But on July 18 of this year, the Supreme Court reversed the lower courts' decision and acquitted each of the defendants. The top court ruled that failing to comply with the ministry's guideline did not constitute a violation of the Securities and Exchange Law, as the guideline itself lacked established authority at that time.

The guideline in question was the directive issued by the Finance Ministry in March 1997 with regard to the assessment of banks' assets. Under this, the ministry told each bank to classify their assets according to the borrower's fiscal health and set aside a provision against possible loan loss in the future. The point of argument in the trial was whether this guideline was the sole fair accounting standard and whether it was illegal if a bank failed to comply with it.

From the beginning, there was an argument that indicting Onogi on charges of accounting fraud was off the mark, as he took office as president only after the bank's rampant ill-advised lending to questionable borrowers - the cause of its failure - had been conducted during the bubble era by his predecessors. They had avoided being held responsible because of the statute of limitations.

The cardinal point in this issue, however, was the relationship between banks and an MOF that had governed the Japanese banking industry for decades - that is, the ministry's overwhelming control over banks. The ministry famously dictated banks' behavior to every detail, finding a fault or two in anything they did. In other words, the ministry demanded near absolute obedience from banks on the strength of its regulatory power - likened to telling someone when to pick up their chopsticks and when to put them down during a meal.

The relationship was incestuous too, as the ministry demanded loyalty from banks in exchange for guaranteeing protection from whatever difficulties they might encounter. The so-called convoy system of protection was meant to never allow a bank to sink - the pillar of postwar Japan's banking administration. But the convoy system became unsustainable in the post-bubble financial crisis and was virtually abandoned, shifting to a system that emphasized self-responsibility on the part of banks. The case against the former LTCB executives was brought about in this moment of transition.

The convoy system, backed by the Finance Ministry's unchallengeable power, deprived financial institutions of their instinct for independence and freedom of management. Over the decades, they had become highly subservient to the ministry's directives.

Searching for answers

Following the Supreme Court decision acquitting the former LTCB executives, major newspapers unanimously questioned, "Who was responsible after all?" They openly wondered where the Finance Ministry's responsibility lay.

In connection with the U.S. subprime loan debacle, a similar question is being raised stateside. Who is at fault? Some even blame former Federal Reserve Board Chairman Alan Greenspan for a monetary policy that paved the way for a housing bubble.

But in Japan, this question looks far more relevant given the regulatory power the Finance Ministry had exerted over the banking industry. The Supreme Court ruling highlighted the point 10 years after the monetary crisis, showing once again that it is still a query very much alive. In truth, the LTCB acted as it did in line with the Finance Ministry's desire to keep the bank's crisis from surfacing by putting it off.

The regulatory power of the Finance Ministry over the banking industry has subsequently been ceded to the newly created Financial Services Agency, and the relationship between authority and industry has changed considerably. Nevertheless, the country is not yet entirely free from the problems of excessive governmental power and interference with the private sector, not to mention the question of who should be held responsible once something goes wrong.

(Originally appeared in the July 28, 2008 issue of The Nikkei Weekly, reproduced here with permission.)

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