Mired in Bad Debt, Asia Faces Further Struggle

Ron Fullerton and his wife, Lita, found out from the morning radio news that Manila-based Urban Bank had collapsed, taking with it their dreams and about $140,000 in savings.

But the loss reverberated far beyond their family. The savings account funded their life’s work: an orphanage called the Chosen Village Foundation that housed more than 70 disabled children in the mountains south of the capital. For months they barely got by and were forced to sharply limit the number of additional children they could help.

“It was a shock,” Ron Fullerton said. “That money was the children’s future.”

Two years later, the Fullertons have recovered only a fraction of their loss from the bank’s failure. Investigators blame the bankruptcy on slipshod accounting and corrupt lending practices that favor bankers’ cronies, practices that have helped create mountains of unfunded and unredeemable debt.

Across Asia, from the tip of Northern Japan to the southernmost island of Indonesia, bad debt is far more than the corpses of defunct financial institutions or the huge numbers on the balance sheets of those banks struggling to keep above the rising flood. It’s a scourge that diminishes the lives of millions of ordinary people even as it threatens to stoke political instability and halt the region’s three decades of economic growth.

Bad bank debt lacks the headline-grabbing qualities of an earthquake or an airline crash. But once out of hand, as it clearly is in Asia, its destructive power is far greater. Today it’s destroying jobs in Indonesia, breaking apart families in Thailand, spurring suicides in Japan.

Add up the pieces and Asia has a $2-trillion bad-debt problem. That’s equivalent to the combined annual economic output of California, Oregon, Washington, Nevada, Arizona, New Mexico, Utah and Idaho.

“Asia’s biggest danger is in its nonperforming loans,” said Jose de Venecia, speaker of the Philippines House of Representatives and a former presidential candidate.

Bad debt, essentially money that lending institutions have lost all or part of due to borrowers’ inability to repay, leaves some banks so weak they fail, while others that survive often have no money to finance new growth.

On the face of it, the problems are strikingly similar from country to country. Loans with no hope of being repaid are overwhelming borrowers who feel as though they’ll never get ahead. Lending practices are irresponsible at best and criminal at worst. Governments deny the scope of the problem in the vain hope an economic miracle around the corner will make it all go away.

However, economic, cultural and political differences, the public’s appetite for pain and the mettle of individual leaders will greatly affect the approach each country takes and the number of years or decades it will need to craft a solution.

As governments continue to look for a painless way out, most economists insist there will be no free lunch. Eventually, someone will have to pay in the form of expensive taxpayer bailouts, restructurings that ultimately will cause thousands of bankruptcies, millions of lost jobs and more strain on wobbly democracies.

And as is so often the case, a disproportionate share of the pain is expected to fall on the poor.

Asian Development Bank economist Jean-Pierre A. Verbiest estimates the loan problem will shave as much as 2 percentage points off annual output--in a region that has long depended on prosperity to paper over internal and external tensions. This in turn will leave the global economy further dependent on the United States, which has been the only consistent engine over the last decade.

Far and away the largest splotch on the regional radar screen is Japan, which accounts for an estimated $1.3 trillion in bad debt, or about two-thirds of Asia’s total.

The irony is that a nation that led millions of Asians out of poverty by pioneering export-led “miracle” economic growth is now a leader in reverse.

“Japan is a horrible model,” said Bill Belchere, Singapore-based regional economist with Merrill Lynch. “Unfortunately, what Japan’s demonstrated for the region is that you can put off dealing with banking-sector problems indefinitely to protect the status quo. Others can look at Japan and say, ‘Why should we do anything?’”

Economists say Japan promises to be among the last economies in the region to overcome its debt morass, with pessimists arguing that the world’s second-largest economy could see another decade lost to recession.

Even under conservative government estimates, bad debt in Japan amounts to 8% of gross domestic output compared with the 3% for the U.S. at the depths of its savings and loan crisis. And official statistics have been notoriously suspect, as with most Asian nations.

Japan has studied the U.S. and Swedish bank recovery models in excruciating detail, knows all the latest theories and what it arguably must do. “Every time I talk to Japanese, they know more about our S&L; crisis than we do,” said U.S. Ambassador Howard H. Baker Jr.

Finding the political will to do it, however, is another story. Although no nation likes to throw people out of work, shutter inefficient factories and alter cherished beliefs, Japan’s long-standing emphasis on social cohesion, its enormous wealth cushion and its general distrust of bold policy have left it with a sumo-wrestler-size problem.

“Japan’s tendency to postpone is at the root of this current mess,” said Michiyasu Hirao, director of global studies with Mitsui Research Institute. “Losses end up just getting bigger and bigger and bigger.”

Japan, China and South Korea also differ from the rest of Asia in the type of institutions they’re trying to protect, namely large, inefficient conglomerates with cozy ties to bureaucrats and politicians.

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China’s Leadership May Recognize Problem

China, second-worst-off in the region with bad debts officially pegged at about $400 billion and other estimates placing it much higher, has certain advantages and disadvantages in its bad-debt battle relative to its neighbors.

Although most other economies watched their bad debts balloon over the last half a decade because of systemic flaws in their interpretations of capitalism, Communist China never made much pretense of allocating labor or capital for other than political purposes. The transition to a more market-driven economy, however, now leaves banks struggling to pursue the contradictory goals of central planning and rampant capitalism.

Though China’s economic progress is impressive, far exceeding expectations, China’s banking problems in close concert with dinosaur-like state-owned companies are equally impressive. Recent worker revolts as wages have gone unpaid are a hint of the problems Beijing is juggling, partly because of the need to cope with debt.

Working in China’s favor is a top leadership that appears to recognize the problem and one that doesn’t face elections, which gives it the luxury of taking tough actions that are politically unpopular. There are signs, for instance, that new bank loans are going to high-growth industries, unlike the case of Japan where they’re all too often used to prop up obsolete industries.

Bank oversight and senior personnel decisions also have been shifted from provincial to central government control to cut down on meddling.

“The leadership isn’t in denial as the Japanese are,” said Fred Hu, a Hong Kong-based executive director at Goldman Sachs. “They recognize this as a big problem.”

In addition, China’s recent entry in the World Trade Organization should sharply expand foreign competition, thereby aiding leaders in their drive for internal change.

Still, China’s outlook is hampered by a fundamental problem faced by generations of Chinese leaders: Policy emanating from Beijing often is ignored by corrupt, lazy or defiant local officials.

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Korea Moved Quickly at Brink of Bankruptcy

Most analysts give South Korea the best marks in the region, helped by a relatively strong political will and a national consensus for reform. President Kim Dae Jung pushed hard early in his administration as billions in bad loans were sold off at a fraction of their face value, bank managers were replaced and giant chaebol conglomerates allowed to fail. A slimmed-down banking industry now employs 97,000 people, down from 144,000 four years ago.

South Korea also had less choice than the others after a near-death experience in 1997 when the country found itself just days from bankruptcy and was forced to take the bitter medicine handed down by the International Monetary Fund.

Koreans cite another key factor: a culture that favors moving quickly and decisively during difficult periods, rather than following the more cautious approach seen in neighboring Japan and elsewhere.

“Korea survived 5,000 years sandwiched between the oceanic power of Japan and the land power of China,” said Kim Cheon Hong, executive director of Korea Asset Management Corp., charged with selling off the bulk of South Korea’s distressed assets. “If it’s time to change, in the law of the jungle you change.”

Although Korea did a lot of backsliding once the immediate crisis was over, analysts say, it has the best chance of growing its way out of trouble during the next economic upturn.

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Philippines Could Avoid Problems of Indonesia

Farther south, the Philippines is a country at the crossroads, analysts say. It could see steady improvement with the right policies or deteriorate further like giant Indonesia to the south.

The Philippines never enjoyed as vibrant an economic fest as many of its neighbors in Southeast Asia did during the late 1980s and early 1990s. And its banking problems are more closely associated with outright crooks and cronies than some of its neighbors.

The percentage of bad loans has crept up during the last year to more than 18%, but calls recently have grown louder for creation of the nation’s first privately funded asset management companies charged with buying distressed bank debt and injecting new capital into the system.

“We’re trying to jump-start the economy,” said Leonilo Coronel, executive director of the Bankers Assn. of the Philippines.

Bringing up the rear and the furthest from a solution in most analysts’ minds is Indonesia. Other countries struggle to find a political mandate for tough restructuring moves, but Indonesia has its sights set on a far more basic goal: crafting a working political system.

Collecting bank debts in Indonesia from borrowers perfectly able to repay often is next to impossible because of the political climate and the weak legal system. Some of the biggest debtors are sitting in parliament.

One Jakarta-based foreign banker who asked not to be identified recalls the simple, one-word answer he received after advising a client to pay off a bad loan: “Why?”

The role of bad debts in dragging down economic growth has particular resonance in Indonesia, said Raden Pardede, chief researcher at Jakarta’s Danareksa Research Institute. The economy needs to grow at twice its current 3.5%-to-4% rate just to absorb the estimated 2.7 million job seekers entering the market annually.

“If conditions don’t improve, I think there will be a social explosion within five years,” Pardede said.

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‘The Ordinary Taxpayer Pays the Price’

Banks and bankers rarely are loved in any country, particularly when tales of abuses hit the headlines. Asia’s respect for tradition and hierarchy makes it culturally difficult to force out elites running the banks, government agencies and companies no matter how great the malfeasance.

Well-run banking systems and efficient capital markets are the lifeblood of any modern economy. And cleaning up after well-heeled financiers may be a necessary price for the additional jobs, new opportunities and reduced angst that follow, economists say.

“Ultimately, it’s always the same story in every country,” said Jack Rodman, Tokyo-based partner with Ernst & Young Consulting. “It’s the ordinary taxpayer who pays the price.”

As Western developed nations pressure Asian nations to improve their oversight, bolster their accounting systems, protect small shareholders over powerful financiers and end cozy deals among politicians, bankers and corporate titans, one word comes up repeatedly: Enron.

The energy giant collapsed in a matter of weeks after accounting problems were publicly disclosed, says Merrill Lynch’s Belchere. Its top executives were paraded before Congress and a roaring debate got underway on overhauling the accounting system and reforming political fund-raising.

“As respected a company as Enron was, it was shut down,” Belchere said. “Enron has probably happened 1,000 times out here in Asia and no one’s ever done anything about it.”

Back in Manila, meanwhile, the Fullertons are trying to put their life together even as the sordid details of the Urban Bank failure seep out.

A World Bank report found that rampant insider lending, few controls and little transparency led to the institution’s downfall, which affected about 5,000 depositors and creditors with the equivalent of more than $250 million tied up in the bank when it went under in April 2000.

Ron Fullerton’s sense of disbelief at the crumbling house of cards was even greater because he had been friends with several of the bank’s executives through a local Rotary Club, including one who acted as a trustee to the orphanage.

For the first several months after the collapse, the Fullertons and the orphans lived on petty cash and donations. The orphanage also was forced to stop taking in additional children.

But a front-page article in a Manila newspaper on their plight generated gifts of food, clothing and money, which helped keep the orphanage going through the summer months when donations traditionally dry up.

For more than a year, they lived hand-to-mouth. Then, last summer, the government approved a bank restructuring plan that allowed depositors and creditors to withdraw as much as $10,000 of their lost money, with promises of more later. That has allowed the Fullertons to start accepting children again.

“Theoretically, we may get everything back,” Ron Fullerton said. “But of course, that depends on whether the new bank survives.”