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The plot that triggered Tokyo’s plunge

The soaring Tokyo Stock Exchange prevented Japan's Ministry of Finance from realising its ambition to restructure the country's smaller banks and securities houses. So, in concert with the Bank of Japan, it engineered the crash that sent the Nikkei plummeting. To outsiders, Japan's financial regulators appeared to be in open conflict. And the lack of clear guidance caused the jitters that greased the skids under the TSE. Tony Shale reports on the plot that fooled the world.


The collapse of the Japanese equity market in 1990 was orchestrated by the country's Ministry of Finance and the Bank of Japan. The world's two most powerful financial regulatory bodies acted in concert to fabricate a story that they'd fallen out with each other; that their once unbreakable and incestuous alliance was over. They figured the Japanese markets would implode if deprived of their unquestioning belief in the coherence of Japanese monetary policy.

They figured correctly. Between the time they started sending out signals of their incipient divorce in late 1989 and early April 1990 the Nikkei-225 index fell over 10,000 points (25%). The story was bought both at home and abroad. Commentators in New York and London celebrated the demise of the Japanese financial system. They believed that a fracture in relations between the MoF and the BoJ would rob both of the power to guide and influence the market in Japan.

But the onlookers failed to consider that the MoF had a vested interest in the tailspin of the Nikkei. To cut off the flow of easy money to financial and corporate Japan that the Tokyo Stock Exchange had provided would lead to the realisation of the MoF's long-cherished desire – the coordinated restructuring of the Japanese financial services industry. This had been long stalled by the ability of the nation's smaller (and most inefficient) banks and securities houses to resist rationalisation because of the buoyancy of the markets.

It was thus entirely in the authorities' interests to have all believe that they were engaged in a public dispute. But insiders know a different story: not one of conflict but, rather, one of close coordination of policy between the MoF and the BoJ.


In an early-April interview with Euromoney, Tatsuya Tamura, director of policy planning at the Bank of Japan, said: "Throughout [the first quarter of 1990] we have been acting in accord with the Ministry of Finance. Nothing has changed in the structure of the Japanese political decision-making system."

This could have been a public relations exercise to play down reports of a rift between the MoF and the BoJ. Or was it the literal truth – that there never was any disagreement between the two authorities? Though they gave out signals to the market to the contrary, to believe that a rift existed was to mistake intent for dissimilation.

Market practitioners question the received wisdom that the authorities had fallen out. "I don't think there has been any conflict between the Ministry of Finance and the Bank of Japan," says Takatoshi Okuyama, general manager of the international advisory department at Daiwa Securities.

"The so-called 'crash' in Tokyo was nothing of the sort," says Robert Zielinski, senior analyst at Jardine Fleming Securities in Tokyo. "It was orchestrated by the authorities who used the apparent conflict between them as a ploy to bring down a Tokyo Stock Exchange that was heavily over-inflated. This was done to bring to an end an era in which cheap capital was available to all Japanese companies. Why? In order that they be forced to focus on the restructuring, deregulation and rationalisation of some very underdeveloped sectors of the domestic banking and corporate economy in readiness for the day when foreign imports are finally allowed to penetrate Japan."

"The total breakdown of the relationship between the Ministry of Finance and the Bank of Japan is only apparent," says Calvin Puckett, president and chief executive officer of Morgan Trust Bank in Tokyo. "We know only what we are told unofficially and what we read in the press. This, in tum, is a classic feature of Japanese policy-making."

Zielinski believes that the MoF’s primary motive is to create an environment in which mergers and acquisitions (M&A) in the financial services sector become a reality for the first time in Japan.

Jean-Paul Renoir, chairman of Shearson Lehman Hutton Asset Management in Tokyo, shares this view. In a report entitled Perspective on Japanese financial deregulation: what does it really mean? he writes: "The MoF began to believe [in the aftermath of the October 1987 crash] that the real key to future economic strength was its newly acquired financial power, and that it could take the lead over the manufacturing sector.

The "constituents", however, have refused to toe the line. The legions of Japanese regional banks (over 130) and smaller securities houses have resisted what they see as selling their birthright in the name of rationalisation. While most were able to reap the benefits from artificially inflated real-estate and equity markets which, in turn, made their balance sheets look artificially healthy, they were under no real pressure to partake in a M&A revolution."To make Japan the world's strongest financial power or, in other words, to make the world's financial markets synonymous with Japan became a new objective. At this point, the MoF is no longer simply reacting to foreign and domestic pressure, but is starting the process to initiate a new framework and a new set of objectives for its 'constituents' and for Japan."

Now that the MoF has rewritten the rules by deflating the markets, these recalcitrant minor players will have little choice but to take their place in the ministry's restructuring plans. Bankruptcy would be the alternative. But, as one foreign expert in Tokyo points out: "In Japan there is no such thing as bankruptcy. The MoF controls a system that does not allow for individual failure. And it is not about to stand by and wait for a repeat of the US Savings and Loans debacle."

Other side effects of the stock market collapse are worth noting. Long concerned by the build-up of hot money in Japan's land and equity markets, which have produced a highly leveraged TSE, the MoF was eager to punish those responsible.

According to Paul Hofer, senior vice-president and manager of Credit Suisse Japan: “The trigger for everything we witnessed in the first quarter of 1990 was the MoF's decision to eliminate speculative money in Japan's markets. Estimates of what this amounts to range from ¥5 to ¥7 trillion ($33-$47 billion). In 1989, Japanese companies were using the Eurodollar markets to raise money in multiples of what they needed for capital investment and this led to a huge overflow of speculative money into the stock market."

The decline in the Nikkei hurt the speculators. The Big Four securities houses reached an agreement with the MoF on March 20 to stop equity-linked financing activities. By April 4, the stock market plunge had already forced the cancellation of 97 equity, convertible bond and cum-warrant bond issues worth ¥3 trillion for the first and second quarters of 1990. With this the recent propensity for large issuers to play the markets was also brought to a halt.

Meanwhile, the estimated 10 to 15 big speculator groups and the 50 to 75 smaller ones that have grown fat on the rising Nikkei were "facing devastation" by early April, according to one analyst. "The prices of the 200 or so speculative stocks on the TSE have fallen much more rapidly than most," he says. He also points to the April 5 disclosure of the speculative investment group Akebono Kikaku that it could not honour a promissory note to Tokyo Sowa Bank for ¥221 million ($1.3 million) as a sign that it was "the beginning of the end" for the speculators.

It is also worth noting that by appearing powerless to arrest the decline of the yen, the stock market plunge and the increase of interest rates in Japan, the ministry and the central bank have demonstrated to politicians, trade negotiators and market practitioners overseas that the all-pervasive manipulation and control of the nation's markets and financial institutions of which Japan's bureaucracy stands accused is nothing but a myth.

This would be some coup to pull off, especially at a time when the United States has raised the stakes in its trade war with Japan by attacking, through the Structural Impediments Initiative talks (due to be completed in July), the very heart of what it sees as unfair Japanese trading practices.

And it is perhaps significant that those in Japanese financial circles who insist that the row between the ministry and bank is real claim that this is a natural step in the country's process towards the internationalisation of its bureaucracy. Michiya Matsukawa, senior adviser to the president at Nikko Securities and a former vice-minister of finance for international affairs at the Ministry of Finance (the MoF's most powerful position), says: "In the United States we witness a very similar discrepancy in opinions between the Federal Reserve Bank and the Treasury Department.

"And it is the same in West Germany where Karl-Otto Pohl comes from the Social Democratic Party while the government is Christian Democratic. Japan is now simply following the international pattern. In the past Japan has been regarded as a country where everything is agreed on quietly and privately without conflict among the financial regulatory bodies. Now Japan is also seen as a country where the ministry and the central bank air their differences in public."


Minister Hashimoto (left) and governor Mieno: the private and public faces behind the Nikkei's tumbling value.

While arguments rage over the nature of the "conflict", all agree on its effects: that the appearance of disharmony has been one of the major causes of the decline of Japan's markets. "A chain reaction was established," says Kermit Schoenholtz, a vice-president of Salomon Brothers Asia, "where apparent disputes between the Ministry of Finance and the Bank of Japan weakened the credibility of monetary policy in the eyes of the markets. As a result, when monetary policy was tightened it failed to stem anti-yen sentiment which in turn weakened the bond and equity markets."

Puckett of Morgan Trust agrees: "The equity market would not have declined quite so much, certainly in terms of volume, if monetary policy had been clear."

Most agree that the appointment of Yasushi Mieno as Bank of Japan governor in December 1989 was the starting point for the "conflict". Mieno entered the BoJ in 1947 and, apart from a few years at the start of his career spent in New York, has worked since 1965 exclusively on domestic banking issues. During the five years he served as former governor Satoshi Sumita's deputy he seemed, says one BoJ watcher, "dazzling in his anonymity". His preferred modus operandi was to listen patiently to advisers before adopting a consensus decision, say insiders.

All this seemed to change on his elevation to governor. Suddenly he became the champion of tighter monetary policy, the strident scourge of inflation and, if you believe the conflict story, the strident opponent of the Ministry of Finance. He has certainly won some applause since. "With Mieno's arrival, we recognised a change in attitudes at the bank of Japan," says Schoenholtz at Salomon. "He began to exhibit strong opinions and deserves a lot of credit for going public with his views."

Go public he certainly did. In speeches, communiques and his weekly press conferences he began to question the asset price inflation of Japan's real estate and stock market and signalled his desire for an official discount rate rise to stem the decline of the yen. Autumn interest rate increases of one percentage point in Europe demanded reciprocal action in Japan, he maintained.

At this point the Nikkei-225 was soaring towards its December 29 record of 38,916 and excitable sections of the Japanese securities industry were heard calling for a year-end push to force it over 40,000. "We were overoptimistic at the time," says Okuyama of Daiwa. "The consensus seemed to be that interest rates would decline and that the yen would become stronger in the first quarter of 1990. We were looking for the benefits of the peace dividend and were excited about the unification of East and West Germany."

Salomon Brothers wasn't overoptimistic and became the only house in Tokyo, Japanese or foreign, to call the market right. In contrast, Nomura Securities hosted a press evening on February 14 in which a manager of the institutional research and advisory department confidently predicted that the Nikkei-225 would reach 45,000-50,000 by year-end 1990.

Salomon's Schoenholtz says: "As soon as we saw that Mieno was showing concern about high land prices, the fall of the yen, the tightness of the labour markets and the pace of economic growth, we realised that monetary policy would definitely tighten.

"From there it was natural to expect an increase in long-term interest rates at a time when short-term interest rates were high and to foresee a Japanese government bond sell-off. This, we realised, would produce a large yield gap between the equity and bond markets and would exert downward pressure on the equity market which would accumulate over time to push the equity market down. So on January 11, we [strategist Christopher Mitchinson in London] revised our forecast for the Nikkei-225 which was then standing at around 39,000 to 32,000-35,000."

The market obliged as the Nikkei fell to 37,188 by the end of January and to 34,591 at the end of February. The December 25 overnight deposit rate (ODR) hike of one-half a percentage point to 4.25% failed to do its job of settling the yen. It fell from ¥143 to the dollar in early December to ¥147 in January. As the markets continued to decline and the yen to weaken, the ODR was raised again by one percentage point to 5.25% on March 23. By this time, Salomon had again revised downward (on March 8) its Nikkei forecast to 27,000-30,000. Again it was right: at the end of March the index hit 29,980.

With Mieno's arrival, we recognised a change in attitudes at the bank of Japan... He began to exhibit strong opinions and deserves a lot of credit for going public with his views - Kermit Schoenholtz, Salomon Brothers

But as Schoenholtz is careful to point out: "At no time were we convinced that the fundamentals that the Bank of Japan was concerned about were weak. We were able to call the market accurately because we recognised that sentiment, rather than fundamentals, would in part cause the sell-off in the equity market – negative sentiment, that is, produced by the seeming inability of the Ministry of Finance and the Bank of Japan to agree on monetary policy."

Here lies the root of what has been perceived as the 'conflict': that the BoJ was prevented from acting on its fears about asset and price inflation in a timely manner through ODR increases because the MoF did not share its view and, apparently, shackled its freedom to manoeuvre. Japan's equity and bond market players, who traditionally have been able to discount any news about monetary policy well in advance of officially released data or news, were left without any clear guidance. The result was the slide of the markets.

But while there is ample evidence showing what the BoJ's motives were in the form of governor Mieno's frequent public pronouncements, the views of the MoF were far from overtly stated.

Views differ on this. Schoenholtz, for example, believes that the MoF was signalling its intention, albeit in its usual roundabout manner. "I think there is enough evidence to show that the MoF was more cautious than the BoJ about the rate rises and that it expressed itself differently about its priorities," he says. In evidence, however, he points only to the few public comments Minister of Finance Ryutaro Hashimoto made during the past few months.

"These seem to suggest that the MoF wanted to avoid action that would seriously affect Japan's equity markets because it was worried that declines in Tokyo would spill over to world markets. It saw Japan's role as the anchor for world markets and was careful, as such, about its international responsibilities. The BoJ, meanwhile, was more concerned with correcting what it saw as domestic problems and its international objectives for Japan were for it to act as an anchor for world price levels."

Others are far from convinced. "The Ministry of Finance is, I believe, not really unhappy about the events of the past four months," says Toby Myerson, senior managing director of Nomura Wasserstein Perella in Tokyo.

"Never did the Ministry of Finance make its position clear on what it really thought of the declining markets or that it was really in fundamental disagreement with the Bank of Japan's stated fears," says the general manager of one foreign securities house in Tokyo.

"But then publicity is something the MoF has never courted," he continues. "Its preferred route is to leak its views to the Japanese press where comments are attributed only to 'sources close to the ministry'. And if you consider the wild behaviour of the Japanese press over the past few months, you can soon see that the papers have been left without this customary direction and that the MoF has been giving none of its usual guidance via the media."

Throughout the past four months the normally tame Japanese press has indeed been unpredictable. The week April 2-6 is a good example. The Nihon Keizai Shimbun (the leading Japanese financial daily) started that week with a lead article that Japan's life insurance companies were about to launch a massive sell-off of their domestic equity portfolios. As well as having an immediate dramatic effect on the market – it plummeted 1,978 points on the day – this article was wildly inaccurate. As was pointed out by hastily convened press conferences by the leading life companies which pointed out that their only possible investment strategy toward the TSE would continue to be "buy and hold".

Tokyo_stock exchange_780

A cooling of the Tokyo Stock Exchange – it plummeted almost 30% – was part of the master plan to force greater efficiency upon the financial services industry.

During the same week the press was also responsible for rumours that a senior executive at newly-formed Mitsui Taiyo Kobe and a Yamaichi Securities official had both committed suicide, that one of the Big Four securities houses was facing impending bankruptcy and that Nomura Securities was unable to meet futures-related payments. All had an injurious effect on the market and all were vehemently denied.

"The crazy stories meant one thing," says one observer. "The MoF was holding back on leaks, guidance and direction. Its silence indicates particularly that it was not averse to further downward pressure on the market. And generally that it had no great case to make in opposition to the Bank of Japan."

The BoJ's view is instructive. Asked why a joint public statement was not offered by itself and the MoF to cool the volatile markets, Tamura of the BoJ replied: "We didn't think it was necessary. Even if we'd called a joint press conference, matters had gone so far that maybe no one would have believed what we said. And we both felt that in the end we would be able to gain the understanding of the people and the markets." Cynics in Tokyo interpret this another way. They claim that the BoJ was reading a script carefully prepared for it by the MoF. The once-docile governor Mieno was given a new part to play by the MoF in which he would change from Clark Kent to Superman. In this new role he could drive Japan's over-inflated stock market down to a level more acceptable to the MoF while the latter drew no criticism from Japan's investors for having burst the TSE balloon.

Zielinski of Jardine Fleming goes much further: "In the 1980s the primary aim of the Ministry of Finance was to keep the yen strong so that Japan's export industry could be developed. At the same time it fully recognised that Japan's markets were impregnable to imports. By keeping interest rates down it also encouraged a huge flow of capital to the stock market and, with the market soaring, it gave every Japanese company which desired it to raise cheap money in the Japanese equity markets.

"Japan's financial institutions and corporations have raised over ¥76 trillion ($506 billion) over the past five years. The only requirement for access to this capital was to pay a small annual dividend. It enabled Japan's banks to rebuild their capital base, the brokers to retain substantial amounts of earnings and Nippon Life to become the largest life insurance company in the world.

"Having reached a point where the nation's export businesses had been supplied with sufficient low-cost capital to consolidate their overseas growth, the MoF had then to combat the negative effects of asset price inflation. It decided that another year of bullish stock markets was unnecessary and that the corporations had raised enough money as they could use. They had started to raise unnecessary money for speculative purposes and were fuelling land price speculation. For the past decade this had been desirable because it supported the fundamentals of Japanese corporations while the risk of default was zero. This, in turn, was beginning to cause serious social dissension as the Japanese became classifiable into rich or poor depending on whether they owned land or not.

"So the MoF decided a decline in the stock market was necessary and effected one of nearly 30%. And it did so because it wants the 1990s to be the decade of domestic reconstruction. A high stock market was a positive disadvantage to this: because it propped up the small, inefficient banks, securities houses and companies and thus prevented the M&A activity vital to consolidation. Now these will be forced to concentrate on profits and generating real earnings because investors will begin to rate shares on much lower price/earnings values. And if they don't produce the earnings, they'll be taken over."

He calls it the MoF's "master plan"; to precipitate a decline in the TSE to force the sluggish and the small to become efficient. And he believes the financial services sector is the MoF's primary target.

Renoir of Shearson Lehman Asset Management agrees: "The Ministry of Finance was unable to get the deregulation it wants in Japan's financial services going. It was failing in its attempts to persuade the smaller banks and securities houses to fall in with its restructuring plans because the bull market conditions protected their balance sheets. Now it won't have to persuade them. Rather they'll have to be bailed out. Which means that now there's going to be a lot of M&A in the domestic financial services industry that was not possible before."

To accept this view is to accept that the MoF, far from suffering an erosion of power through its struggles with the BoJ, has consolidated its control over Japan's financial system. And Renoir believes that it will play the leading role in the reconstruction that will precede deregulation: "The MoF will seize this opportunity to play marriage broker to those houses which will need to merge. It will become a glorified investment banker that charges no fees."

Myerson of NWP says: "The MoF knows that, if it continues its policy to prevent the failure of financial institutions in Japan, the banking system will have to be rationalised. The MoF is aware of what has happened in the US. Over-banking and over-regulation have produced an environment in the US which is not suitable for building global financial service institutions. The result is that of the world's top 25 financial institutions ranked by market capitalisation, not one of them is a US bank. The MoF, however, will ensure that deregulation is done in such a way as to encourage consolidation. In the banking arena especially there will be increased consolidation. There are already a number of conceptual pairings being made."

Myerson thinks that the recent marriage of Mitsui Bank and Taiyo Kobe Bank was an early example of this trend. A senior official at one of the three largest Japanese trust banks says that he expects another alliance between two of the medium-sized city banks to be announced in the near future. And he, along with many, singles out Bank of Tokyo as a very likely merger candidate.

So the MoF decided a decline in the stock market was necessary and effected one of nearly 30% - Robert Zielinski, Jardine Fleming

For purposes of meeting Bank for International Settlements (BIS) capital adequacy requirements, Bank of Tokyo has been particularly hit by the depreciation of the yen because, compared to other city banks, it has a much larger proportion of its assets denominated in foreign currency (56%). And of all the city banks, it recorded the highest year-on-year growth in assets last year (24.6%, compared to Dai-Ichi Kangyo Bank's 15.1%). At the same time it has also been hit harder by the MoF's requirement that the banks increase their provisions against LDC debt from 15% to 25% because, with ¥663 billion in LDC loans, its exposure is around double that of the other city banks.

Its BIS ratio has hovered around the 8% mark and plans for an equity issue last month were scuppered by the collapse of the TSE. "It's getting to the stage where Bank of Tokyo might fall into the 'rescue merger' category," says the trust banker. An M&A expert in Tokyo also thinks it likely that the banks will shortly marry. "Bank of Tokyo is probably thinking about an alliance. It is very strong overseas but is domestically weak. [It has a branch network in Japan of only 32 branches compared to 588 for Mitsui Taiyo Kobe and 367 for DKB.] A merger with one of the many Japanese banks that has no overseas presence to speak of would probably be attractive."

While mergers between the larger banks are certainly a popular topic of conversation, the MoF is more anxious to push through the consolidation of the regional banks. "With the demise of the stock market meaning the end of cheap money for the regional banks, it is now very likely that they will fall into the hands of the bigger city banks," says Zielinski. "Many of the regionals are barely profitable while they carry large fixed costs. Banks, for example, one-fiftieth the size of DKB will often have one-tenth the number of employees and one-quarter the number of branches."

The city banks have been preparing for the day when they will absorb their smaller regional counterparts. Their encroachment has been gradual and has usually involved buying up a small percentage of the regionals' shares and sending staff as directors. As of March 1989, according to a recent report by Barclays de Zoete Wedd in Tokyo, Industrial Bank of Japan was the largest shareholder in 25 regional banks and had placed directors at four of these banks. Fuji Bank ranked second with 23 banks and seven directors. It should also be easier for the MoF to control the consolidation seeing that it has directors at 47 of the regional banks while the BoJ also has directors at 45.

Regional banks have been weakened by the equity crash. Kagoshima Bank, for example, which has also been the target of speculative groups, suffered a fall in its share price of nearly ¥3,000 to ¥860 between March and April. This will make it all the easier for the MoF to pressure it into a merger.

The securities houses have been similarly weakened. Compared with the end of 1989, Nomura's share price was down 45.7% by early April, Daiwa's down 45.3% and Yamaichi's 43.8%. But while analysts estimate that the impact of falling commissions and lost underwriting revenues may cut profits in half for fiscal 1991, they do not expect them to face serious financial difficulties.

Rather, as in the case of the banks, it is the smaller securities houses that are likely to suffer. Consolidation and mergers are again to be expected. But while the smaller banks are likely to fold into the larger ones, the MoF will prevent the Big Four houses from enlarging their franchise (which, according to some estimates gives them a more than 60% share of all Japanese securities business). And so it will be into the arms of the banks that the lesser securities houses will be forced to go.

The major banks already have strong relations with an array of securities houses, often owning the maximum 5% of shares they are permitted under present legislation. The influence they exert by sending staff to serve as directors means that these ties would be easy to convert into total control.

All of which would lead to a likely abolition of Article 65, Japan's equivalent of the US Glass-Steagall Act. And even if it didn't produce physical deregulation, Article 65 would become a meaningless piece of paper. As Renoir says of the law: "It will simply become redundant."

It is interesting in this light to notice a change in attitude at Daiwa Securities toward deregulation. When its president Masahiro Dozen spoke to Euromoney on the subject in December 1989, he declared: “Article 65 will not be removed in Japan. There is no need for it to be so.” In April, Okuyama of Daiwa noted: "I believe Article 65 will be modified. Discussions are going ahead on schedule. This is a requirement, a long-term tendency."