NEWS ANALYSIS : How Long Can Japan’s Market Be Propped Up? : Exchanges: The Ministry of Finance has been intervening regularly to bolster stock prices.

As Japanese stock prices moved toward dangerous new lows last March, uneasy officials in the Ministry of Finance’s squat, gray headquarters convened a strategy session.

The issue at hand: Should the ministry try to stop the market’s decline before the Nikkei stock index plunged through the psychologically important 20,000 level?

Nobuhiko Matsuno, then head of the ministry’s securities bureau, brushed off officials’ calls for intervention by insisting that it was not the ministry’s role to control stock prices. The ministry did nothing, and stock prices plummeted, falling an additional 28% to 14,309. The slide only stopped in August when a panic-stricken ministry finally intervened with “emergency measures.”

“We tried the free-market approach,” says an official recalling the sequence of events. “It didn’t work.”

Instead, since August the Ministry of Finance has been intervening regularly to prop up stock prices, including ordering companies not to sell shares, leaning on big institutions to buy shares and coordinating purchases of shares with public funds. The depth and breadth of government intervention in the market shows the extent to which Japan remains deeply distrustful of the ability of the “free market” to resolve its economic ills.

The latest government-led effort to boost stock prices came last Thursday. Early in the day, investors flocked to the shares of steel and shipbuilding companies on rumors of a government plan to encourage the development of double-hulled tankers that reduce the danger of oil spills. But the buying spree turned into a full-fledged rally in the afternoon when managers of government funds began buying shares.

“The buying was done as loudly as possible; it was a publicity stunt,” says Peter Boyce, a trader with brokerage house James Capel’s Tokyo office. “They wanted to get everybody on the bandwagon.”

Boyce says Japanese institutional investors and large brokerage houses typically talk among themselves, enabling them to move in a coordinated fashion and increase the impact of a modest amount of government pension funds going into the market.

Some of the buy orders were even channeled through foreign brokerage houses to make it appear as if foreigners were moving back into the market, Boyce says.

The Nikkei closed up 3%, at 17.063.41. The market fell back a little Friday, closing at 17,023.78. But Japanese traders say the rally, which enabled the market to close the month above 17,000, was psychologically important because stock performance in January has typically been regarded as a harbinger of trends for the remainder of the year.

These government-led stock market operations may indicate a return to the close ties between brokers and the Finance Ministry that helped drive stocks higher in the past but led to foreign charges that Japanese players manipulated their stock market. The cozy ties broke down when the Finance Ministry was forced to crack down on brokers in 1991 for compensating large customers for their stock market losses. Angry brokerage houses claimed that the compensation schemes had been sanctioned by the ministry.

Foreign analysts say the new intervention program may also prolong the agony of the market by making it impossible for investors to know just how low the market would fall in the absence of government manipulations. The intervention could also dangerously backfire if a large wave of anxious sell orders suddenly overwhelms government defenses.

Fear of such a selloff is one reason the government is intervening so heavily. Lower stock prices recorded at the end of the year would have reduced the value of equity holdings of major banks and forced them to cut back on lending to meet international rules regulating capital ratios. Such cutbacks could, in turn, abort a hoped-for recovery.

Brokers now say the market will hold through March but that there could be an “April crisis” when banks have closed their books and there is less urgency on the part of the government to prop up prices. “When you have an artificial market, you can’t sustain it forever,” says Kosaka Uano, head of research at New Japan Securities. He says the market’s ability to maintain current price levels will depend on whether the government makes a substantial policy move to pull the economy out of its slump, such as an income tax cut.

Meanwhile, knowledge of government intervention has kept investors out of the market and hurt securities companies that depend on trading volume for their earnings.

Recent history suggests that government intervention in markets has been accomplished in large part by manipulating large institutions. The government’s first major move last year came in mid-August, when Finance Minister Tsutomu Hata said banks were in the most “severe situation since World War II.”

Hata outlined emergency measures to bail them out and protect them from stock declines. Banks and insurance companies were publicly ordered not to unload any of their huge stock holdings unless they could find a buyer and sell the shares off the market.

Meanwhile, accounting rules were loosened to dissuade corporations from selling shares to dress up their books. The ministry also promised to channel more public pension fund money into the stock market.

Initially, the medicine worked. Share prices rebounded sharply. As doubts emerged over the ministry’s commitment to boosting the economy, however, prices began to slide again. In mid-November, the market dipped below the 16,000-level as a result of selling on the futures market by pessimistic foreign investors.

This time, it was unclear how direct a part the Finance Ministry played in the rescue operation, but Japanese securities companies splashed onto the market with huge buy orders. American investors who had been shorting stock--trying to profit from the falling market-- suffered huge losses.

To keep stocks from falling back again, the Finance Ministry allocated $22 billion in public pension funds for investment in stocks. Only one-third of the money has been used so far, and fund managers are being told to invest the rest of the money before the end of March.

Since large institutions are still on orders not to sell and trading volume is low, the stock buying for pension funds often accounts for as much as one-third of all market orders and prevented the market from falling much below 16,500.

Finance Ministry officials say they are not investing public savings in an irresponsible manner. They say they are confident that lower interest rates, improved corporate earnings forecasts and shrinking inventory are about to shift sentiment in a positive direction and drive shares upward.

But they aren’t about to take a laissez faire attitude and take the chance that investors might have a more pessimistic view of the economy’s future. If the market were to start tumbling again, says one Finance Ministry official, “you don’t know where it would stop. It could have a serious impact on the economy.”