ensues. During the period of high growth that lasted until the late 1980s, Japan's financial system seemed invincible. The economy grew at an annual rate of 4 to 6 percent for so long that everyone took it for granted that this would continue indefinitely. When, in the early 1990s, it slowed to 1 percent or less, the system began to fall apart.
The aim of the contraption the Ministry of Finance had rigged up for Japan's financial world was peace or, rather, stasis. No bank could ever fail; no investor could ever lose by playing the stock market. Everywhere, cartels and monopolies ruled, guided by the firm hand of bureaucrats. This desire for peace, for no surprises, is such a strong factor in traditional Japanese culture that the Law of No Surprises comes first in my personal Ten Laws of Japanese Life. There is no better paradigm for this than the tea ceremony, where detailed rules determine in advance every slight turn of the wrist, the placement of every object, and virtually every spoken word. No society has ever gone to such extreme lengths to rein in spontaneity. In the industrial arena, employees rarely change companies; small start-ups do not challenge established large firms. Concrete slabs armor river-banks and seacoasts to guard against any unwelcome surprises from nature.
The Law of No Surprises means that people find it difficult to let go of failed policies and cut their losses-a process that we will see at work in many fields in Japan. The inability to cut losses is what underlay the Daiwa Bank scandal of July 1995, when the U.S. Federal Reserve discovered that Daiwa had hidden $1.1 billion of trading losses from federal authorities, and also the Sumitomo Trading scandal of October 1996, in which a copper trader for Sumitomo Trading in Great Britain ran up $2.6 billion in secret losses. Both cases involved a spiraling series of bad trades that lasted years-in the case of Daiwa, for more than a decade. Neither the traders nor their parent companies were able to call a halt at an early stage.
Traditionalists hold the hallowed word
The trouble is that the world does in fact change, and as it does, inflexible systems grow increasingly removed from reality. Small losses accumulate into torrents of red ink, as Daiwa Bank and Sumitomo Trading discovered. A beautiful stock exchange, lovingly engineered with a thousand clever devices so that prices will always rise, results in the biggest banking fiasco the world has ever seen. With a twist: in banking fiascos elsewhere, banks typically go under; in Japan, with a few exceptions, the government cannot allow that-so the nation has paid the price in other ways.
There is a moral to the story, and it strikes at the root of authoritarian societies everywhere. The Soviet Union under Brezhnev, Japan under its bureaucracy-each is an example of a society that believed it had achieved eternal balance: central planners had everything under their control. Change, and all the social chaos to which it gives rise, had been banished. But alas, we can never banish change. Machiavelli writes: «If a man behaves with patience and circumspection and the time and circumstances are such that this method is called for, he will prosper; but if time and circumstances change he will be ruined because he does not change his policy... Thus a man who is circumspect, when circumstances demand impetuous behavior, is unequal to the task, and so he comes to grief.»
One aspect of Japan's failure to keep in touch with reality was that the Ministry of Finance and Japan's banks and brokerage firms failed to acquire the technology used in financial markets elsewhere. This may be one of the most surprising aspects of the Bubble, for it runs against the common wisdom about Japan's alleged gift for high technology.
If debts need never be repaid and stocks produce no yields, what is the measuring rod of value? There was none, aside from Madame Nui's toad. In the 1980s Japan's securities houses, dominated by Nomura, towered over all competitors and many believed them to be practically invincible. But traders at Nomura and other brokerage houses did not learn the mathematical tools that Wall Street brokers developed in the 1980s, and that led to the complex computer trading and new financial instruments that dominate the market today. Since 1991, they have seen one long series of retrenchments, with Nomura consistently losing money, or barely scraping by in the United States and Great Britain. Daiwa cut its foreign branches from thirty to eighteen in 1999; Nikko reduced its overseas operations; and Nomura is closing foreign desks. By January 1998, Japanese securities firms had fallen completely out of the ranking for the world's top-ten bond dealers. Nomura made it only to No. 13; the other firms did not get into even the top twenty. And by then foreign brokerage houses were handling almost 40 percent of all trades on the TSE. In the fall of 1997, Yamaichi Securities, one of the Big Four brokerages, declared bankruptcy when more than $2 billion in losses surfaced in hidden offshore accounts. And then there were three. «Just as the U.S. brokers toppled England's largest securities firms, the same thing is happening here in Japan,» said Saito Atsushi, Nomura's executive managing director.
However, there was to be one last mission for MOF's financial machine to accomplish, albeit a suicide mission. MOF decided that it should expand into Asia, which it considered Japan's natural sphere of influence. Land prices had been rising in Thailand, Malaysia, and Indonesia for decades-all the old Bubble rules still seemed to apply there. So Japan in effect exported its Bubble to Asia, lending heedlessly to build office towers, shopping centers, and hotels, as was done in Tokyo and Osaka years ago. «We are just asset eaters,» says Sanada Yukimitsu, an associate director at Tokyo Mitsubishi International in Hong Kong. «The Europeans and Americans consider profitability, they manage their assets. If there is no profit, those banks just withdraw. But Japanese banks lend even when the price isn't so good.»
And lend they did. Asian countries modeled their markets on Japan: under the leadership of strongmen such as Indonesia's Suharto and Malaysia's Mahathir, governments set values, and told large investors what to buy, and they obeyed. From MOF's point of view, Southeast Asia was one last blessed corner of Eden that was still free of dangerous wild animals like P/E ratios and cash-flow analysis. From the mid-1990s on, Japanese banks doubled and tripled their loans to Southeast Asia, providing the lion's share of loans to Korea, Malaysia, and Indonesia, and more than half of all foreign money lent to Thailand.
There is an old Yiddish joke that asks: Question: What does the saying mean, Though he slips and falls on the ice, the Avenging Angel will still catch up with you? Answer: He's not called the Avenging Angel for nothing! Alas for MOF. In the fall of 1997, the Avenging Angel arrived in Southeast Asia waving the flaming sword of «real value.» The Korean, Thai, Malaysian, and Indonesian currencies collapsed overnight. Suharto and Mahathir watched in helpless rage as the markets, long used to obedience, went their own way: down. The mistake of the Asian nations was to lower the walls around their credit systems, something Japan would never do – hence when the crash came they could not control it as MOF did in Japan.
A massive financial meltdown of the sort that had been taking place slowly in Japan over seven years happened within a few months. Japan's banks, whose loans to the region were four times those of U.S. banks, are writing off tens of billions of dollars of bad debt. The results for Japan, however, are not entirely negative, for while the banks lost heavily, Japan's manufacturers benefited from the Asian crisis to snap up businesses and properties at bargain prices. Much is at stake in MOF's new offensive in Asia. Japanese banks and stockbrokers are in such trouble at home, and have lost so much business in the United States and Europe, that if their Asian policy does not succeed they may languish permanently as second-class citizens in world finance. «What's left if this fails?» asks Alicia Ogawa, the head of research for Nikko Salomon Smith Barney. «That's a good question.»
Meanwhile, what about the
One of the more puzzling aspects of post-Bubble Japan has been the unwillingness to reform a market that has obviously failed. By 1996 it was clear that drastic changes would be necessary, and MOF came up with the idea of a Big Bang, a deregulation modeled on the market-opening of the 1980s in London, when the «Big Bang» sparked dramatic growth in the London financial world.
The problem is that Japan's banks and securities firms rely for their very life on unreal values. Like Japan's rural villages and their dependence on dam building, the banks are hooked on the narcotics of these unreal values, and kicking the habit will bring about severe withdrawal symptoms. Deregulation in Japan, scheduled to take place over several years starting in
1999, has turned out to be anything but a Big Bang. Speaking on the subject of Japan's reforms in 1996, Sakakibara Eisuke, the director of MOF's International Finance Bureau, announced, «We bureaucrats are giving up all of our power.» This was followed, according to The Wall Street Journal, by «a quick outline of how Mr. Hashimoto's Big Bang program would unleash market forces. But then Mr. Sakakibara made an important qualification. 'Of course,' he said, giggling, 'we can't allow any confusion in the markets' – a phrase bureaucrats often invoke to justify a go-slow approach to reform.»
The go-slow process began immediately The insurance industry, due to open to newcomers in 1998, won a reprieve until 2001 – or later. The Ministry of Finance announced that banks must set aside capital against bad loans under a system known as «prompt and corrective action» but quickly began to water down the standards, phasing in the rule piecemeal, applying it first to large banks and only later-if ever-to small banks, where most of the trouble lies. As Japan entered the twenty-first century, the hype about the Big Bang had died out, and it was consigned to dusty shelves as just another government report. It was business as usual in Tokyo.
This brings us to a striking feature of Japan's post-Bubble trauma: paralysis. Instituting a real Big Bang is simply out of the question, for the whole edifice of Japanese finance might crumble if MOF allowed economic rationalism to infiltrate. It has been said that the Bubble losses were not as severe as they seem because they were merely «paper losses» – but for Japan, paper losses are a serious issue because the very genius of MOF's system was its ability to inflate assets on paper: Japan's rapid postwar development depended on it. So when troubles began to appear, MOF trod very gently, afraid to make any sudden moves.
The concept of «latent profits» has come home to roost in the form of «latent losses.» Banks lent heavily to real-estate companies that own land now valued at a fifth or a tenth of the price they paid for it a decade or two ago. As the real-estate companies go under, these properties become the problem of their lenders, but rather than write down the losses year by year on a present-value basis, the banks have kept these properties on their books at purchase value; the moment they sell, they must suddenly report huge losses. So the market came to a near-complete stop in the 1990s: banks didn't sell because of «latent losses,» and few bought because not enough transactions occurred to lower the prices to profitable levels.
Paralysis also rules in the stock market. The amount of money raised by new stock offerings in 1989 was ¥5.8 trillion; by 1992, it had fallen to ¥4 billion, a shocking 0.07 percent of what it had been three years earlier. By 1998 this figure had crawled back up to ¥284 billion, still a tiny fraction of its earlier height. Another telling statistic is the number of companies listed on the exchange. In Tokyo, that number remained almost flat during the 1990s, while that of the New York Stock Exchange rose by 45 percent.
Overall, the Tokyo and Osaka stock exchanges raised about ¥1.5 trillion (about $13 billion) in initial and secondary public offerings in 1995-1999; the equivalent for the same period on the combined New York and NASDAQ exchanges was considerably more than $600 billion, a truly staggering difference. To get a sense of the scales of magnitude involved, consider that in the first three months of 2000 alone the NYSE and NASDAQ raised $92 billion through public offerings, far more than the total raised in Tokyo and Osaka over the entire past decade. The original purpose of a stock market is to provide a forum for companies to sell equity to the public, but the TSE abandoned this role for ten years; for most intents and purposes, it was shut down.
Remarkably, in spite of all this, very little has changed in Tokyo. It is important to realize that as Japan enters the new millennium its financial system remains
