Investors Shop for Bargains in a Changing Japan

Amid deep gloom and great anxiety about Japan’s economy, investment bankers and financiers are flocking here from all over the world to make deals because they sense a turning point.

Many are American, and they are buying busted real estate properties and bad loans from banks at great discounts.

Investment banker Morgan Stanley is said to be buying 1,200 condominium units from Daikyo Inc., a troubled developer, for $93 million.

Credit Suisse First Boston, in an alliance with Secured Capital, a Los Angeles firm, recently purchased $1 billion worth of nonperforming real estate loans from Mitsui Trust for $75 million, or 7.5 cents on the dollar.

Bankers Trust has bought into Nippon Credit, GE Capital bought Toyo Insurance and Merrill Lynch is hiring refugees from the bankrupted Yamaichi Securities.

It is a remarkable turn of events, a mere decade after Japanese investors paid outrageous prices to buy “trophy” properties such as buildings in New York’s Rockefeller Center, Hotel Bel-Air in Los Angeles and Pebble Beach golf course near Monterey.

And as the Japanese learned then, there are no sure bets in this world. Many of the deal makers now crowding the elegant lobby of Tokyo’s Imperial Hotel will lose money, even buying at less than a dime on the dollar.

“Americans don’t understand the different ways the Japanese think about land prices and real estate, just as we didn’t understand U.S. cash flow returns,” says Yuichi Ishikawa, who developed One Colorado Center in Pasadena and now heads a construction company in his native Tokyo.

Still, the Americans’ timing could be right as rain.

“The Japanese economy has hit bottom,” declares Richard Koo, chief economist of the Nomura Research Institute. “This is the first time since the bubble burst in 1990 that real changes are being made.”

Criticism for Dithering

The foreign investors are placing their bets as international criticism of Japan for dithering on the laggard economy reaches fever pitch--and on the eve of what people like Koo believe is a fundamental, if belated, change.

The government has made a U-turn in policy in coming to the support of the economy and the banks, Koo says, predicting that currency and stock markets will soon take notice. He expects the yen to rise against the dollar, perhaps returning to a ratio of 110 yen to $1, a rate last seen in 1995.

By U-turn, Koo is referring principally to the $120-billion program of public spending and tax cuts Prime Minister Ryutaro Hashimoto is pledging in order to revive Japan’s economy. Details of Hashimoto’s plan--and the all-important question of tax cuts--are imminent.

Such massive steps will bring a revival no doubt, at least for now. And that will help the economies of Southeast Asia, which waxed prosperous over the last decade on investment from Japanese industry and have been devastated by the sinking of Japan’s economy.

The United States will also be helped, although a fall in the dollar’s value could lead to higher interest rates and the long-awaited “correction” on Wall Street.

But pump priming is only a short-term fix. The real question in Japan today is whether the country will move to correct its deeper structural problems.

They include $600 billion worth of bad loans held by Japanese banks, the legacy of 1980s real estate excesses and more recent ventures in Southeast Asia; severe overcapacity in Japanese industry--production plants built to export goods to the world that are a burden now that the world has changed; the difficulties Japanese companies have in earning a good return on investment, which leads to the difficulties Japanese pension funds have in earning the return needed to support Japan’s coming surge in retirees.

In many ways, Japan today is entering a period of industrial restructuring comparable to what the U.S. went through in the 1980s, but perhaps more painful for Japan because of its recent tradition of job security--not really lifetime employment, but close.

The investment bankers gathering in Tokyo today believe that Japan will restructure its economy. One early sign is the so-called Big Bang reform that began April 1, opening up the nation’s financial services industry to international competition.

Giving the investors further confidence is the country’s great hoard of household savings, roughly $10 trillion in guaranteed postal savings accounts, small bank deposits, home safes and mattresses.

Giving them pause are the vested interests in Japan’s economy, from its army of powerful government officials to corporations and individuals who have had it good under a 50-year system of protection and government direction.

Postwar Economy

Japan’s economy for most of the half-century since World War II demonstrated one of the greatest advances in history. The government of a devastated nation in the late 1940s, with the encouragement of the U.S. occupation forces led by Gen. Douglas MacArthur, created industries to employ the people.

It then told the people to save their wages in government-guaranteed postal savings accounts. Wage income would be taxed at rates that today reach 65%, but interest income from those postal accounts for decades was tax-free.

The government funneled the resulting savings through the country’s main banks back into investment in industry, starting a buildup of capital and industrial might that came to astound the world.

It was a government-planned economy but an efficient one, unlike those in the formally socialist countries. Government control was not absolute; independent companies could follow their own agendas. Shoichiro Honda, a motorcycle manufacturer, decided, against government advice, to make automobiles.

Jobs in industry were all but guaranteed and so was the survival of the larger companies. In times of difficulty, bank loans were always made available to tide over a company division or a new undertaking.

Shareholding was, and is, a mutual affair, with companies holding shares in each other. There were no messy shareholder lawsuits or objections at annual meetings. But also there were no rigorous accounting standards to measure true loss or profit, true return on investment.

Nor was outside competition a problem. Japanese companies exported to the world, but access to Japan’s market was carefully controlled.

The system was productive, and economic growth was rapid for several decades, but the last 15 years or so have seen diminishing returns.

Growth naturally slowed as the economy matured. But the system did not recognize maturity. The circle of cheap capital paying for more and more industrial capacity continued, and it led to fierce overcapacity. Japan today has 7 million car registrations a year but is capable of producing 14 million cars--and all the materials that go into those cars.

“There is overcapacity in steel, chemicals, rubber, semiconductors and many other materials,” explains Akio Mikuni, founder of Japan’s first credit rating agency, itself an innovation much in demand today as bankruptcies loom.

The lack of concern with returns on investment led to distortions. Japan’s companies don’t make much profit. According to Mikuni, the real credit-worthiness of 60% of the major companies on Japan’s stock exchange is at triple B or below--junk bond levels.

As the companies make low returns, so do the Japanese pension funds that invest in them, and that has led to a worrisome specter for retirement savings in the fast-aging nation. The savers whose postal accounts are the ultimate source of Japan’s capital also earn very low returns, 1% or less, and are increasingly worried and dissatisfied.

The easy accounting and easy loans have led to a banking crisis and the threat of depression. Japan’s banks as of this year must meet international requirements for soundness, and so have been scrambling to collect loans that are in many cases uncollectable.

Bankruptcies are increasing among small companies, and some not so small. Toshoku Ltd., a fruit trading company, sought protection from creditors in Japan and the United States after its Japanese bank refused any longer to roll over its loans. Toshoku went into reorganization in Japan and the U.S. owing $6 billion, says Kenji Nakashima, a lawyer who has been appointed trustee in the bankruptcy.

Creditors may receive less than 10 cents on the dollar when Tokoshu is brought out of bankruptcy, Nakashima says. And that could take 19 years, given the details of Japan’s bankruptcy laws.

But that is not the important point for the future. When Toshoku, and other companies, come through reorganizations in this time of trial and propose to compete in the world, they will need international accounting standards to keep distortions from happening again, Nakashima says. “They will need instruction in how to be international companies.”

The Big Bang

The first dramatic changes the world will see in Japan’s economy are in financial services. The opening of Japan’s financial system to foreign participation, the Big Bang, already has Fidelity Investments, Merrill Lynch, Morgan Stanley, Goldman Sachs and particularly Citicorp preparing for a big market among Japan’s return-starved savers.

Less immediately visible but more profound will be the changes that will come in Japanese industry as it makes up for lost time in information technology, where it lags the U.S. and even Europe.

“What is occurring in Japan today is a sea change forced by the advance of information technology,” says T. Yoshitami “Tom” Arai, chairman of Systems International, a Tokyo-based consulting firm.

Arai knows all about change. In the late 1950s in New York, he and Akio Morita rented a warehouse and set up the U.S. operations of Sony Corp., one of the first overseas ventures of any postwar Japanese company.

Sony and other companies went on to create modern industrial history. And now, back in Japan, Arai sees history beginning again.

Amid gloom and anxiety, Japan is at a turning point.