Avoiding Lost Decades #1: Corruption & Scandal & Reform! Oh My!
The Economic Consequences of the Mitsubishi/Dai-Ichi Kangyo Bank Scandal From 1979 to 1984
©1991 Tokyo University
Tokyo University Economics Department
Original Edition: Tokyo University Press, Tokyo: 1991
English Translation: Wallflower Press, New York: 1992
On November 17th, 1979 the Mitsubishi Bank Ltd, one of the major banks of Japan, was undergoing a routine examination by a low level government employee of the Ministry of Finance. This procedure involved a wide but shallow forensic examination of an arcane section of the Mitsubishi Bank's loan agreements to their corporate partners. At the time the Ministry of Finance was operating in a distinctly friendly manner towards the banking system nominally under their regulatory jurisdiction and Mitsubishi Bank had nothing to worry about as any discrepancies discovered were smoothed away.
If the proper hierarchy in the Ministry of Finance had been functioning the report filed by this junior employee would be seen by his immediate supervisor only. However, the filed report was flagged by the internal mailing system as his supervisor was on vacation. The report was sent to the Ministry of Justice, where it was read by a senior employee who was inclined to follow up.
Over the next six months (December, 1979; January-May, 1980) the investigation widened to include, most notably, the Dai-Ichi Kangyo Bank, Limited as well as a number of smaller banks. They were discovered to be holding roughly 10% of outstanding loans as non-preforming loans (NPL) or "bad debt" without holding reserves to counter them. At the time this was not against Japanese law.
The NPLs was in service to the rapidly increasing demands placed on them by their associated corporations (keiretsu) who were entering the global market in force, placing greater pressure both on their finances and their need for capital to counter foreign takeovers.
Despite having uncovered nothing technically illegal the investigation continued because the size of the NPL's was unprecedented. In May a confidential memorandum was found (deliberately misfiled) that outlined a pattern of collusion between the banks and the Ministry of Finance to conceal the NPLs. Using this as a wedge additional corroborating data was soon found, and the scandal entered the public's conscious.
The investigation had been little noticed by reporters and news agencies up until then but the Ministry of Finance links proved irresistible. Public outrage when the investigation and preliminary findings became public (despite government attempts to control the information) centred on the level of corruption that must have been involved, but a vocal minority were more concerned with how much the banks cared about corporations and assets, rather then the retail market and direct customers as in most other developed countries.
Japanese dissatisfaction with the banks—outside the corruption issue—manifested itself along a distinct inferiority complex: why are Japanese banks unable to be as good as American banks in serving retail customers?
Perhaps if the endemic corruption characterized by the Lockheed Scandal of 1976 had not been so fresh in people's minds the Bank Scandal would have blown over, but uncharacteristic anger at the banks (and their corporate partners) and the Ministry of Finance manifested itself into a situation that was viewed as unacceptable by the Japanese public—flatly refusing to accept the rational for the Ministry's actions.
In the spring of 1981 the ruling Liberal Democrat Party lost a vote of confidence, and the nation went to the polls. This is not the paper to cover elections in detail, but in short the coalition government of all opposition parties combined won the election. The Democratic Parties of Japan, as the unwieldy collection of disparate political parties united only in acting against the government was known, promptly passed a very large banking and financial sector reform law. Equally promptly they then collapsed, bringing the LDP back to power.
The law was broad reaching. The Ministry of Finance was removed from the decision making loop; the banking and corporate sector were brought under a set of transparent accounting standards, subject to random audit with large penalties for failure; and the banks were forced to keep reserves on hand to deal with bad loans.
The net effect of the law was to discourage "bad" loans, those that are known to be non-performance, and to return the Ministry of Finance to a properly neutral regulatory role.
As for the Non-Preforming Loans that started the scandal, the government bought them and promptly wrote them off—however the government also forced the banking sector into a series of structural reforms above and beyond the newly written laws. This structural reform would cause a shake-up and rethink of the keiretsu system, although the full details are outside the scope of this paper.
In 1981 the Japanese economy slowed noticeably, having fallen to a growth rate of only 3.4%. Although considered strong in isolation, compared against 1980's 4.8% it was merely average.
A major reason for the drop was that corporations had been cut off from easy credit as a result of reforms, and the banks had been divorced from the Eurobond market as it was no longer worthwhile for them.
The government ideal solution was to reduce savings incentives in the short term, to spur consumer demand, and to drop the governmental portion of the economy back to 1970 levels.
Negotiations with several opposition parties finally produced a durable majority for the LDP, and they went ahead with their plans. Therefore, in 1982, the LDP began their neoliberal period. It started with the deeply unpopular expansion of the consumption tax to a 10% rate, which would be used to enable tax reform in income & corporate areas. It continued with the also unpopular post office privatization, which was to reduce saving incentives (e.g. the post office didn't tax your account until beyond 10,000 USD and they allowed anonymous accounts; given that are thousands of post office outlets you need never pay tax on your savings) and spur consumer demand. Post office privatization also satisfied the coalition opposition parties as a major source of corruption money could no longer be used.
(The coalition partners main demand to go along with these economic reform packages centred on widespread political reform, but that is also outside the scope of this paper.)
Economic disruptions from the banking reform and the economic reform packages had also set in, and the ambitious early wave of global Japanese companies were forced to re-entrench, bringing in outside (Western) consulting and concentrating on smaller and more strategic targets then before. The so-called prestige targets of early global Japanese corporations were abandoned.
Positive signs included several times more foreign direct investment in Japanese corporations, although the keiretsu system continued to keep Japanese companies reasonably safe from the kind of hostile takeovers becoming more popular in the United States.
The reduction of credit from banking structural reforms and post office privatization forced Japanese corporations to modify their export heavy strategy and to focus on profitability instead of market share. Combined with keiretsu whose banks who were now much more wary this shifted Japanese corporations into a more cautious posture.
With the overall amount of investment dollars vastly reduced for the next several years corporations were forced to rely on Japanese consumers, leading to rapidly improved retail operations most notably in the banking sector, but also in many other corporate areas.
In 1983 the growth rate was an anemic 2.2% (down .7% from 1982), and the government became increasingly desperate. Using the additional revenue from the increased consumption tax the LDP conducted a radical overhaul of the tax code as well as sharply cutting both income and corporate tax. Furthermore they followed the American deregulatory lead (although in a rather different fashion) in most markets.
This was the third major shock to the banking sector in only three years. From vast reforms, to the entry of the post office as a private corporation, and now to so-called "smart" deregulation combined with tax cuts.
Nevertheless the banking industry was adaptable and had low debt (as their their NPLs had been paid for by the government), and supported by strong consumer demand in the last quarter of 1983 they embraced reform—forcing reluctant corporations along with them—and began increasing their exposure in the lending market (while continuing to follow the new rules requiring them to be prepared to cover bad debts, this required Japanese banks to keep deeply focused on profitably).
However the yen was rapidly strengthening as well, due to a combination of an improving economy at home and various overseas factors. The Bank of Japan originally considered drastically easing the monetary supply by lowering interest rates, and flooding the country with cheap credit[1]. However the lingering reminders of the Bank Scandal's easy credit and non-preforming loans tainted that option. The Bank of Japan instead embarked on a Print Yen policy, adopting a controlled inflationary target of 1% for the next 10 years.
The consequent drop in the Yen improved the export situation combined with newly available investment dollars was a major boon to Japanese corporations and they used their solidified home base and increased profits to once again enter the international market in force.
With an increased desire to use their savings (due to the newly introduced inflation eating away at them) 1984 was a record year for small businesses. This coincided with the return of investment dollars to the Japanese economy as the economic outlook brightened, and so existing but expanding small businesses and new start-ups could count on higher amounts of bank money than before. The so-called 1984 Businesses
With a weakened yen, strong consumer demand, newly expansive corporations, and a Japanese corporate sector that now cared about the Home Islands more than before 1984 saw an astounding 5.6% growth rate.
(1985, 5.2%; 1986, 5.8%; 1987, 6.0%; 1988, 4.9%; 1989, 4.4%; 1990, 4.6%.[2])
With their fortunes now secure electorally the LDP continued the pace of reforms, concentrating on free trade, the elimination of agricultural subsidies, and overall economic productivity (notably government R&D spending grew several hundred percent in 1985).
The late 1980s has been equally good to Japan, but of course is attributable to the Bank Scandal only indirectly (though a direct path can be traced, the amount of data and economic modelling required to establish solid empirical connections is prohibitive).
In short the reforms that began because of scandal have led to a much healthier Japan. The corporate and bank sector underwent much needed reforms, whose urgency had been masked by high economic growth. The subsequent economic problems caused by the required restructuring created a new government culture willing to embrace reform, which led to far reaching changes in the economic, political, and social spheres.
[1] This was the OTL response to a strengthening yen. The cheap credit resulted in over-borrowing, which led to out of control stock & land prices, and when the Bank of Japan decided to dampen inflation starting in May 1989 they went too far in squeezing speculation out of the stock & land market, and triggered the Bubble collapse in April of 1990.
[2] Also, to sum up: 1980, 4.8%; 1981, 3.4%; 1982, 2.9%; 1983 2.2%. That's an average growth rate of 4.53% from 1980 to 1990.
IOTL Japan had a growth rate of 5.1% in 1976-1980 & 3.3% from 1983 to 1986 & about 5% in the late 1980s. Something like 4% overall for the decade. The ATL Japan has beaten or matched that, and will continue to grow in the 1990s.
