Fear Grips Japan's Banking Industry, Mizuho, world's biggest bank down the limit 15%

Only days after Japan's foremost economic reformer was given a free hand, the euphoria about the chances for real change is waning.

Heizo Takenaka, appointed financial services minister on Monday as well as keeping his job as economics minister, has kicked off a top-to-bottom review of banking policy.

But while investors are sick of the trillions in bad debts crippling the banking system and want reform, they are also scared that the pain caused by any cure could be unbearable.

The result: a mass selloff of banking stocks on Thursday, driving the benchmark Nikkei down below the key 9,000 level to 19-year lows as fears of a 'hard landing' grow.

Not all the declines could be put down to concern that the government will force banks to accept public funds in exchange for more honesty about their problem loans.

Heavy falls on Wall Street overnight had accompanied bad news from a string of companies, including chipmaker AMD which warned of rising inventories and falling sales - a worrying echo of the situation as the tech boom turned to bust two years ago.

The Dow Jones index had ended the session in New York down 2.3%, with the tech-heavy Nasdaq Composite down 2.1%.

But the main influence was undoubtedly the banking worries, exacerbated by news that former central banker and key reformer Takeshi Kimura is to join Mr Takenaka's new banking task force.

Of the four biggest banks in Japan, the largest - Mizuho - and the smallest, UFJ, were worst hit by the selloff.

The extent of concern about Mizuho and UFJ was demonstrated by the fate of shares in the other two big players in the banking sector.

Shares in Mitsubishi Tokyo Financial Group and Sumitomo Mitsui both fell by much smaller amounts.

Yeah, I knew what you meant, but it is a drop in an ocean. They do not have 50 bad loans per bank or something. The largest 10 Japanese banks have more than $1 trillion in loans outstanding, in every denomination. There are tens to hundreds of thousands of them, per bank.

Also, you don't seem to understand that "poor performing" is entirely up to the regulators to call the banks on, or not. A zero coupon bond does not default before maturity - and a 1-2% line of credit can be extended at will by throwing good money after bad. The real issue is the impairment of the value of collateral and the impossibility of repayments of principle. It is not the 1-2% interest payments that secure bank deposits.

Understand where the bad loans came from. The banks lent against land and property in the late 1980s when property prices were on the moon (as well as margin loans, which have already crashed and burned). Speculators were mortgaging their buildings to get money from banks, which they then put in the stock market. The stock market crashed, the speculators lost their money, and their land and buildings remained pledged to the banks. But seizing them and selling them dropped the bottom out of the inflated real estate market - where prices had been set entirely by speculators and bank lending practices. The collateral is therefore worth only 10-25% of the value the banks lent on it.

If they foreclose, they get the assets, must sell them, get a modest percent on the dollar, and must book a large loss. That shows they don't have the capital to cover deposits, so to keep deposits safe the regulators would close them down. If instead they simply don't bother to foreclose, and instead extend modest lines of credit, then those can be drawn down to pay low interest on refinanced 1-2% mortgages on fictious capital values. The speculator becomes a "zombie" - a bankrupt kept alive by his creditors. (Notice also that they wind up paying tiny nominal interest rates -set by the central bank, largely - on loan amounts that are actually several times the real value of the property they continue to hold. 1-2% of 5-10 times the present real value is 5-20% times the present real value).

So you understand what we are talking about here, a few basic facts about the land market in Japan. A single square -foot- of land for commercial property along the Ginza, the toniest Tokyo district, runs $10,000. Not per acre. Not the building on top of the land - that's extra. $10,000 per square foot. A marble paved Mcmashion in the US costs on the order of $300-500 per square foot to build new.

And those prices are after falling by more than a factor of 2 since the bubble peak. At the bubble peak, the Australians sold the site of their embassy in Tokyo, moving to a smaller one in a less heated location. The proceeds were enough to repay nearly half the Australian national debt.

The average for all urban land in the country (commercial or residential) is $100 per square foot. That is about what office building property goes for in the US, land included - but in Japan it is the nationwide average from just the land under the buildings.

Land prices rose 118 fold from 1955 to 1995 (wages lagged by a cumulative factor of more than 5 times over that period), or 12.7% per year. They fell at about that rate immediately after the bubble burst in 1989. For the last 8 years, they have fallen 6-7% per year every year - *to* the $100 per square foot level.

Banks regarded land prices as the soundest possible collateral for all loans. They paid little attention to business prospects or cash flow analysis. If the government reported land value numbers were sufficiently high for some amount of unmortgaged land owned by the household or company, they made the loan. Since land values had risen even faster than US stocks have historically, they thought this was completely risk-less, even up to 100% of the land value.

Know how U.S. market bulls said stock returns over the long term always outpace other assets and could be expected to return 10% per year, bad years included? They believed the same thing only more so about Japanese land - even at nosebleed prices having no economic relation to actual uses of buildings on the land.

630,000 Japanese corporations own land (half of them more than tiny amounts of it), carried on their books at a value of more than $5 trillion. 3/4 of the price of a typical Tokyo house is the land underneath it. The average price of a house there is 5 times the price of a similar house in the U.S. Families routinely take out mortgages that two successive generations are expected to pay down before they own a house.

Land and buildings are the largest assets backing financial claims in Japan. (There are 1 million commerical properties in Japan, less than 20k of them are large factories). And half of all financial claims in Japan are in the form of bank deposits or currency - $6.45 trillion. The Japanese money supply is as large as ours is, with an economy 1/3rd the size.

When most of a bloated banking system lends against assets that defy their expectations and decline by half to nine-tenths, you get one heck of a bad loan mess. It is not a few marginal small businesses that aren't making it due to a recession or something. It is a systemic problem, brought on by the interaction of dumb lending practices, inflationary monetary policy, a stock market boom and bust of epic proportions, and nothing much done about it but panic and hide things under the rug for the past decade.

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