Grim facts about bank crisis behind stock market's fall

VIEW FROM TOKYO

History suggests that scares on the Tokyo Stock Exchange, like the 7 per cent drop which jolted the markets last week, are rarely as serious as they seem. The TSE is a robust financial creature. After Black Monday in 1987, it was the least hard-hit and quickest to recover of all world markets; within six months, in fact, it had reached a new all-time high.

In 1992, there was another crisis, when the Nikkei index of 225 leading shares threatened to sink below the panic-threshold of 14,000. But the government discreetly intervened, the discount interest rate was cut and, within three months, the markets had bounced by 15 per cent. The Nikkei might sway in the wind but, rooted in the rich, deep soil of the Japanese economy, and cultivated by the attentive bureaucrats of the Ministry of Finance, it rarely threatens to fall down.

Until the last 10 days, perhaps. Starting last Thursday week, the index suffered a series of daily losses to close on Tuesday at 14,599.68 - down 6.9 per cent in four days, 26 per cent on the year, and 62 per cent from its peak in December 1989.

In the middle of the week, it rallied, then dipped again to close on Friday at 14,703 points. On the face of it, the losses were alarming, but no cause for despair, with stock values still markedly above the crisis level of three years ago. But much has changed in Japan since 1992, as the last few weeks have made clear. Rumours of financial meltdown are absurd, but Japan's financial markets are having to face unfamiliar and unpredictable conditions. So far, it's just the fear of fear, but it is growing.

Last week's drop resulted from a number of overlapping vicious circles. The immediate agents of the fall appear to have been the life assurance companies which have liquidated 2,000bn (pounds 15bn) of risky stocks over the last month - in favour of safer fixed interest securities.

The drop has been accentuated by what in most respects is a welcome development - the bottoming-out of the dollar after months of decline against the mighty yen. The soaring yen made the Tokyo Stock Exchange an attractive market for foreign investors because its appreciation more than cancelled out the Nikkei's decline. Now, this is no longer true, and foreigners who buoyed up the markets for a while are also calling it a day.

Of course, the high yen contributed greatly to the ultimate cause of the stock slide - the sluggish Japanese economy. Export reliant companies have seen their profit margins slashed. Firms have cut recruitment and manufacturers have relocated overseas, boosting unemployment to what for Japan is an alarming 3.5 per cent, and depressing domestic consumer spending. In an effort to avoid large-scale redundancies, they have sold assets, further tightening the deflationary spiral.

But the cause of the most acute anxiety is a long-term crisis in the Japanese banks. During the 1980s, the period of Japan's "bubble economy", commercial property served as collateral for heavy bank lending. But the assets proved to be overvalued, and when the bubble burst in the early 1990s, the banks realised a lot of their money was never going to be seen again. Only recently, though, has the extent of the problem become public, after the Ministry of Finance admitted that dud loans held by Japanese banks equated to nearly 10 per cent of GDP. Unofficial estimates double the figure.

Recently, some of the big lenders have decided that enough is enough. The giant Sumitomo Bank recently announced an annual loss, after writing off bad loans, to wipe the slate clean. Smaller banks cannot afford such bold measures, and the situation is worse because much of their capital is tied up in equities. The combination of write-offs and deflating assets may well be more than smaller banks can bear.

This was what sent the shivers through Tokyo last week - the prospect of banks going to the wall. The fear is intensified by a growing realisation that, unlike the 1992 crisis, the government does not intend to do anything about it.

"The current weakness in Tokyo's stock market warrants vigilance," said the finance minister, Masayoshi Takemura, last week, "but the government is not in a position to take special measures." Interest rates have been cut once already this year, to a nominal 1 per cent, and there is much less money around to throw at the problem. Since the Kobe earthquake in January, the Japanese treasury has run up a small but significant deficit.

The government's hands-off stance seems to reflect a shift in its whole attitude towards the markets and their regulation. For years, foreign governments have complained about "Japan Inc" - the conspiratorial closeness of the ministries and the big Japanese corporations at the expense of small and foreign firms. Now, when the government fails to intervene, there is alarm.

"What do people expect?" asks Jesper Koll, analyst for J P Morgan. "The Bank of Japan is not a candy stall. Some of the banks are already well ahead, but there are going to be losers as well as winners, just as there would be in every other country in the world".