The Ministry of Finance: Bureaucratic Practices and the Transformation of the Japanese Economy [Hardcover ed.] 1567202306, 9781567202304

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The Ministry of Finance BUREAUCRATIC PRACTICES AND THE TRANSFORMATION OF THE JAPANESE ECONOMY

J. R obert Brown, Jr.

QUORUM BOOKS Westport, Connecticut • London

Library of Congress Cataloging-in-Publication Data Brown, J. Robert (James Robert), 1957The ministry of finance : bureaucratic practices and the transformation of the Japanese economy / J. Robert Brown, Jr. p. cm. Includes bibliographical references and index. ISBN 1-56720-230-6 (alk. paper) 1. Japan. Okurasho. 2. Finance, Public—Japan. 3. Japan— Economic policy— 1989- 4. Japan—Economic conditions—19891. Title. HJ1395.B76 1999 338.952—dc21 98-23644 British Library Cataloguing in Publication Data is available. Copyright © 1999 by J. Robert Brown, Jr. All rights reserved. No portion of this book may be reproduced, by any process or technique, without the express written consent of the publisher. Library of Congress Catalog Card Number: 98-23644 ISBN: 1-56720-230-6 First published in 1999 Quorum Books, 88 Post Road West, Westport, CT 06881 An imprint of Greenwood Publishing Group, Inc. Printed in the United States of America

The paper used in this book complies with the Permanent Paper Standard issued by the National Information Standards Organization (Z39.48-1984). 10 9 8 7 6 5 4 3 2 1

To Zoey Ellen Brown and the other ten children adopted from Changsha, China in July 1996: Emily Baribault, Laura Blank, Jade Croghan, Caitlee Mead, Jasmine Pyne, Olivia Ponrick, Gloria Sykes, Caroline Tucker, Taylor Tuteur and Talli VandenBurg.

C ontents

Preface Acknowledgments

ix xiii

I.

Overthrowing the Past

1

1.

Bureaucratic Practices

15

2.

Inside the Ministry of Finance

17

3.

The Ministry of Finance and the Private Sector

32

II.

Management of the Financial Markets

47

4.

The Postwar Financial System

49

5.

The End of the Postwar Financial System

60

6.

Too Close for Comfort: The Securities Bureau and the Securities Industry

71

7.

Bailout: The Banking Bureau and the Banking Industry

93

8.

The Problem of Informal Relations: The DaiwaBank Scandal

112

9.

Lessons Learned: Secrecy and the Bailout of the Jusen

129

III.

Bureaucrats, Politicians and the Budget

147

10.

The Budget and the Bureaucracy

149

11.

The Political Role of Bureaucrats

160

Contents

viii

12.

The Bureaucratic Role of Politicians

171

13.

The Forms of Political Intervention: Cooperation, Consensus and Conflict

181

The National Interest: Politicians, Bureaucrats and the Consumption Tax

193

IV.

Reform

213

15.

The Inevitability of Administrative Reform

215

16.

Retribution and Reform

222

17.

The Endgame: Transforming the Ministryof Finance

229

14.

Notes

245

Interviews

255

Bibliography

259

Index

263

P reface

The impetus for this book arose out of my experiences in the former Soviet Union. Having spent considerable time in the Newly Independent States, I had a chance to observe the economic transformation of these countries. This en­ tailed the casting off of a centrally planned economy in favor of one more reliant on open markets. In general, policy makers in these countries looked to the United States as the primary model to emulate. Implementing the U.S. model meant an elimination of restrictions on foreign exchange, Darwinian competition premised on survival of the fittest and the unrestricted entry of foreign capital. .The role of the government was to be minimized, with market forces driving most economic decisions. While no econ­ omy of the former Soviet Union fully accepted this model, it was the philo­ sophical benchmark used to judge the evolution of the post-command economies. Absent was a debate over other models that may have been more appropriate in promoting economic recovery. Japan represented perhaps the best example of a country that chose an alternative path to recovery. In the post-occupation period, Japan eschewed open markets in favor of a system in which the gov­ ernment (read bureaucracy) played an activist role in the economy. Among other things, the system placed a premium on stability, the avoidance of excessive competition and the availability of affordable capital to key indus­ tries. Foreign exchange controls, interest rate regulation and intrusive govern­ ment involvement in the corporate decision-making process were all prominent features of the system. Moreover, the system worked. Japan’s economy recov­ ered far more quickly than anyone, including the Japanese, expected. Many aspects of the Japanese model were widely used by other countries in Asia. High-growth economies tended to rely on debt rather than equity funding

X

Preface

for capital and on close relations between business and government. They lim­ ited competition and imposed restrictions on foreign exchange. The model helped facilitate perhaps the most dramatic economic growth in history, with South Korea, divided, devastated and poor, becoming the eleventh-largest econ­ omy in the world. Japan at the end of World War II, and the Newly Independent States following the fall of the Soviet Union, had much in common. Both suffered a catastrophe that devastated their economy. Japan’s was the devastation of the war; for the countries of the former Soviet Union it was the devastation of the command economy. Both had to completely rebuild their economic base and both lacked the capital to do so. In many respects, therefore, both needed to catch up to other industrial nations. Japan’s model for economic recovery represented an alternative to the one presented by the United States. The key was a government-supported system of directing capital to industries likely to lead the economic recovery. In countries such as Kazakhstan, with untold wealth in natural resources, the industries that could have benefited from the same approach were obvious. There was no guarantee that the Japanese model would have been transferable to the countries of the former Soviet Union. Among other things, they lacked the tradition of an honest, professional bureaucracy, something essential in post­ war Japan. At the same time, however, the case for U.S. capitalism was not beyond debate. The emphasis on open markets generated enormous economic dislocation, including massive inflation, severe declines in gross domestic prod­ uct, and increased social instability. Banking systems tottered on the edge of insolvency and the industrial base of these countries was sold for “ kopeks.” It was the absence of the debate over the most appropriate model that was striking. Little attention was given to a Japanese-style developmental model as a possible alternative. Instead, some variation of the U.S. economic system seemed to be the only approach seriously considered. The result may be a slower economic recovery than otherwise would have occurred. Nor do current problems in Asia make a convincing case against the Japanese economic model. The problems illustrate that developmental economies could not stay in place indefinitely. Once a certain level of economic recovery oc­ curred, the very attributes that facilitated growth became counterproductive, im­ peding continued development. Existing problems in Asia, therefore, involve the inevitable difficulties that result from the transition from developmental to de­ veloped economies. Difficulties in transition do not establish that the model was inappropriate in the first instance. Japan has been undergoing substantial economic transformation since the 1980s. The country has been gradually casting off its postwar economic system in favor of one more reliant upon open markets. The first country in the postwar era to sustain double-digit economic growth, Japan will become the first to complete the transition from developmental to developed. In doing so, however, Japan is under pressure to adopt a U.S.-style model

Preface

xi

involving ruthless competition, fluid job markets unhindered by notions of life­ time employment, tolerance of business failures and the elevation of conflict over consensus as the principal method of economic decision making. Nor is there any room for a powerful bureaucracy. Having vanquished communism, the U.S. economic system remains triumphant, to be emulated and followed. Japan, however, is struggling to develop an alternative. Deciding to abandon an outmoded economic system, while difficult, is the easy part of the process. What will replace it remains to be determined. While Japan will continue to move toward a more open market system, the issue remains whether it can find its own variant, significantly different from that used in the United States. A Japanese model may yet emerge, one that rejects central tenets in the U.S. approach toward capitalism. Room still exists for a system that places greater emphasis on stability and consensus. Nor will the transformed system necessar­ ily involve an end to the bureaucratic state. The bureaucracy’s role in developing consensus on major policy shifts may well continue, albeit in an altered form. Emergence of this alternative approach depends primarily on the role and evolution of the bureaucracy. While the economic system has undergone sub­ stantial transformation, bureaucratic practices have not kept pace. Still operating on principles suited to a developmental economy, bureaucrats have yet to update their practices to better meet the demands of a market economy. Nonetheless, current developments suggest that the bureaucracy has begun to modify its approach to decision making. To the extent that bureaucrats make the transformation, they may well preserve their central position in the economic decision-making process. Whether they will succeed, however, remains the great unanswered question in the economic transformation taking place in Japan. Those seeking to impose a U.S. model on Japan may well, therefore, be disappointed. Pundits who see an end to the postwar economic system will be correct; those who also see an end to the bureaucratic state will be wrong. Japan will likely emerge as an alternative model, not only for developmental econo­ mies, but for developed ones as well.

A cknow ledgm ents

This book represents the end of an extensive project analyzing bureaucratic behavior in the Japanese economy. In conducting the research, I have inter­ viewed more than 100 people, including politicians, bureaucrats, central bank officials and industry participants. The efforts have taken me to multiple desti­ nations in the United States, often to talk with officials from the Ministry of Finance (MoF) stationed there, and also to Tokyo and Moscow. The emphasis on interviews was not accidental. Much of the system of regulation in Japan operates through personal contacts and informal relations. Conversations with people directly involved in the process are the only way to truly understand how the system works in practice. The research involved an analysis of Japanese sources on the MoF. The Free­ dom of Information Act in the United States also proved a useful tool, partic­ ularly for obtaining information on the $1.1 billion trading loss by Daiwa Bank and the investigation of the activities of the Big Four by the Securities and Exchange Commission. In addition, the National Archives in Washington, D.C., had a wealth of information about MoF policies during the occupation. As usual, I found government officials to be remarkably open once they as­ certained the seriousness of the effort. Moreover, given the uncertainty of the ongoing process of transformation in Japan, officials, particularly those from the MoF, were willing to talk very openly about developments, particularly as they engaged in their own introspective analysis of recent events. To respect their confidentiality, I have deliberately omitted mention of a number of people as­ sociated with the MoF who facilitated this process and provided invaluable assistance. Nonetheless, a number of people who went out of their way to make intro­ ductions and ensure that I met an appropriate spectrum of officials can be men-

XIV

Acknowledgments

tioned. Shijuro Ogata, formerly with the Bank of Japan, not only read an early draft of the book and gave comments but assisted in arranging interviews, par­ ticularly at the Japanese National Diet. Some retired members of the Ministry of Finance spoke with me repeatedly and gave me a glimpse of life during the early postwar period. They included Yusuke Kashiwagi, the first modem international vice minister and chairman of the Bank of Tokyo; Takeshi Watanabe, head of the Secretariat during the oc­ cupation and first president of the Asian Development Bank; and Gengo Suzuki, a rare lateral hire by the MoF who worked in the liaison office during the occupation and was stationed in the Japanese Embassy in Washington during the 1950s. People at Nippon Life Insurance Company also provided assistance. In par­ ticular, Haruaki Deguchi took an interest in the project and shared with me views reflecting his long experience with the Japanese financial markets. Other officials also gave liberally of their time. Yoshikazu Takeda answered my in­ cessant questions. Although many of my inquiries were basic and designed to learn what was probably common knowledge in Japan, he displayed extraordi­ nary patience. I found my visits to the National Diet particularly rewarding. A number of politicians went out of their way to speak with me, sometimes on multiple occasions. They included a good cross section of parties. Of particular note were my interviews with Yasuhisa Shiozaki in the House of Councilors and Takanori Sakai in the House of Representatives, both members of the Liberal Democratic Party, Yoshio Terasawa in the House of Councilors and a member of Sakagaki, and Motohisa Furukawa in the House of Representatives and a member of the Democratic Party. My friend Yoko Nishimura, who previously worked for Fuji TV, arranged some of my most interesting interviews at the Diet. She also, when I had trouble, acted as interpreter at one of them. Russell Munk at the U.S. Department of the Treasury, an individual with considerable Japan experience, gave me a sophis­ ticated set of comments on an early draft. John F. (Jack) Loughran, who worked in Japan for J.P. Morgan for 25 years and is fluent in Japanese, talked with me innumerable times about the difficulties encountered by foreign financial institutions trying to enter the market. His in­ sight and knowledge of events allowed me to better understand the approach used by the MoF in controlling these financial institutions. Tristan Beplat also represented a treasure trove of information. He supervised banks as part of the occupation in the 1940s and had an extended career working in the Japanese financial system thereafter. He is considered to be the one who saved the trust banks, having insisted that the MoF allow trust companies to convert to commercial banks. Tris passed away in 1997, a great loss for anyone studying this area. Chuck Olson, a. longtime Japan hand who now provides financial advice to start-up companies in the Internet industry in Japan, was also kind enough to

Acknowledgments

xv

read a version and take issue with a number of items. While saving me from a number of errors, he rightfully noted the omission of any serious discussion of the Trust Fund Bureau as a weakness in the analysis of budgetary matters. Alan Garber, my administrative assistant, performed most of the drudgery of correcting and assembling the manuscript. His job was made particularly diffi­ cult by my six-month sojourn in Kazakhstan during the final phases of preparing the manuscript. Allison H. Lee, an attorney in Denver, read the entire manuscript for errors that had gradually found their way into the draft. In addition, she conducted some of the primary research, particularly in the area of interaction between politicians and the bureaucracy. She also interviewed a number of key individ­ uals in Japan, including Diet members and other politicians. Two research assistants at the University of Denver College of Law provided considerable help and translation. They were Misae Nishikura and Hideki Maedomari. Hideki in particular translated an enormous volume of Japanese material written about the MoF. Finally, the project would have been impossible but for the funding provided by the Hughes Research and Development Fund at the University of Denver College of Law. The Committee that funded the program consists of Professors Victor Rosenblum and Lawrence Friedman and Dr. Bryant Garth. In particular, Dean Robert Yegge, the faculty supervisor of the Fund, time and time again interceded to assist in the project.

\

CHAPTER 1

O verthrow ing th e P a st

THE BUREAUCRATIC STATE AND THE POSTWAR SYSTEM Few would deny the remarkable success of Japan’s postwar economic system. Devastated, poor, with little natural wealth, Japan went from a Third World to First World nation in less than a generation. Moreover, the country did so not by embracing completely open markets but instead by relying on considerable government guidance of the economy. The postwar system had a number of important attributes. At the political level, stability reigned. A single party, the Liberal Democratic Party (LDP), controlled the levers of power from its inception in 1955 until 1993. That sta­ tistic alone, however, did not tell the full story. In fact, no effective opposition even existed. Irrespective of mistakes, scandals or indecision, it was inconceiv­ able during this period that any other party would govern Japan. In the economic realm, the system was built around stability and support for industry, all in an effort to promote economic recovery. The government rather than industry made many decisions about the direction of the economy. With a severe credit shortage, it was the government that determined who got the scarce resource. Rather than allow banks to allocate funds by raising interest rates, credit was directed toward industries deemed likely to lead the economic re­ covery. Companies got cheap capital; banks an elimination of risk. Everyone benefited except depositors, who subsidized the system in the form of anemic returns on their deposits. The emphasis on stability was particularly clear in the financial system. Com­ petition was limited and lifetime employment guaranteed. Financial institutions were divided into compartments, with each given an area of business to mo­

2

The Ministry of Finance

nopolize. Interest rate controls and restrictions on advertisements meant that competition within each category was limited. The result was a banking system that, until the 1990s, did not see a single failure. Oversight of the postwar system was largely left to the bureaucracy. Bureau­ crats were viewed as the arbitrators of disputes and the enforcers of the system. They participated in all aspects of corporate business. Salaries, dividends, office openings and significant expenditures were fair game for bureaucratic review and comment. The bureaucracy did not act in an autocratic fashion. In general, it acted in league with industry, all in an effort to promote stability and growth. During the postwar period, therefore, Japan was accurately depicted as a bu­ reaucratic state, at least to the extent that the phrase suggested an accentuated role for bureaucrats in the economic decision-making process. Indeed, the bu­ reaucracy played a central if not talismanic role in the postwar system. In the 1970s, however, the system began to unravel. The primary task of the postwar system was economic recovery. Once the task was completed, its raison d ’etre ceased. The guiding hand of the government that worked so well in an era of low labor costs and capital shortages now became counterproductive. As time progressed, the emphasis on stability and lack of competition put Japanese industries at a disadvantage in the global marketplace. The approach built into the system a rigidity that prevented rapid response in an era when decisions, asset allocations and technological changes occurred at an accelerated pace. To maintain competitiveness, therefore, Japan needed to cast off the postwar system and replace it with one more reliant on market rather than government forces. Since the 1980s, the transformation process has been underway. In the financial markets, most of the pillars of the postwar system have been jettisoned. Interest rate controls were eliminated, allowing banks to engage in price com­ petition. The walls dividing financial institutions into compartments were torn down. Foreign exchange controls ended and the traditional emphasis on stability declined. Financial institutions were made more accountable for their mistakes, with some even allowed to fail. THE ROLE OF THE BUREAUCRACY IN THE TRANSFORMED ECONOMY Despite the level of economic restructuring that has already taken place, the task remains unfinished. The most critical unresolved issue concerns the role of the bureaucracy in the transformed economy. The bureaucracy in Japan has clung to power and attempted to maintain its traditional role in the economy, resisting fundamental change. A public debate in Japan has arisen over the continuing role of the bureauc­ racy. Having just suffered from the most prolonged slowdown since the occu­ pation, many in Japan have identified the bureaucracy as the principal cause. Where there had once been a consensus favoring bureaucratic oversight, the vast array of rules, regulations and intrusive oversight suddenly seemed to stifle busi­ ness, harm consumers and reduce economic growth.

Overthrowing the Past

3

In particular, criticism was heaped on the Ministry of Finance (MoF), the most powerful and renowned of the Japanese bureaucracies. Rather than the creator of economic growth, the MoF suddenly found itself transformed into a stasis power that needed to be overthrown for Japan to move forward. Having accepted the plaudits of success, the mandarins in Kasumigaseki now found themselves held accountable for Japan’s economic problems and malaise. Seri­ ous calls arose for the dismantling of the MoF, something unthinkable even a few years earlier. The all-powerful, status quo perception of the MoF has generated two dis­ parate views about the future of the bureaucracy in Japan. One sees a Japan with a bureaucracy that plays a vastly diminished role. Somehow the politicians will assert control and deprive the bureaucrats of their central role in the man­ agement of the economy. Recent efforts to break up the MoF seem to be proof of a resurgent will among politicians. The other view is more pessimistic, seeing no mechanism for elimination of the bureaucrats’ grasp on the country and the economy. Politicians remain too impotent, bureaucrats too powerful. The same evidence suggesting a demise of the bureaucratic state is used to illustrate the opposite. Notwithstanding wide­ spread calls for reform, bureaucrats controlled the process, proof that funda­ mental changes would not occur. Thus, all of the talk of change in bureaucratic authority amounts to a guise, a campaign largely guided by the same bureaucrats that needed to be reformed. Both views have much in common. They impose upon Japan a Western, even U.S., model. They essentially characterize the bureaucracy as an obstacle that needs to be overthrown for the economy to function. They rule out the possi­ bility that the bureaucracy had a central role that, with reform, can continue. In the end the two views differ only over .whether the bureaucrats will win or lose. A third, more uniquely Japanese, perspective on the future is, however, pos­ sible. The Japanese bureaucratic state would continue. Informal relations, gyosei shido (administrative guidance) and amakudari (descent from heaven), all prac­ tices currently vilified, would remain components of the bureaucratic process, although in a somewhat altered form. Foreign businesses would continue to complain of a closed system, although perhaps less vociferously than in the past. In many respects, nothing would seem to have changed. Yet, at the same time, everything will change. Rather than a static institution incapable of reform, the bureaucracy will evolve. Evolution will result as a by­ product of the close connection between politicians and business and the bu­ reaucracy. As their needs change, bureaucratic behavior will likewise have to reflect the new dynamics. As financial institutions emerge from the post-bubble devastation, they are no longer willing to accept the same intrusive role of bureaucrats. Similarly, a new political era has begun, with single-member districts and viable opposition parties. Given these and other developments, the traditional bureaucratic approach toward regulation has become untenable. Nonetheless, as the MoF learns and

4

The Ministry of Finance

evolves, an ongoing shift in behavior suggests that the bureaucracy may yet retain a central role in the economic decision-making process.

THE INFLUENCE OF POLITICIANS Much of the current vilification of the bureaucracy ignores substantial accom­ plishments. The MoF has almost completely dismantled the postwar financial system. The same bureaucracy achieved a transformation of the tax system and balanced the budget, a feat not equaled by financial regulators in any other industrialized country. It also saddles the Ministry with blame that belongs elsewhere. Responsibility for current problems in the economic system, ranging from the failure of the housing loan companies (the jusen) to the bad loan crisis, rests with politicians or industry rather than the Ministry. Mostly, however, the approach ignores the extraordinary responsiveness of bureaucrats to political will. Much of what the MoF has done and continues to do can be explained entirely in political terms. This suggests that change at the political level will lead to change within the bureaucracy.

The Political Role of Bureaucrats Although representing part of the postwar ruling triumvirate, along with the LDP and corporate Japan, the bureaucracy has traditionally been characterized as primus inter pares, first among equals. The political system seemed almost impotent by comparison, an adjunct of the bureaucracy. Torn by factions, con­ cerned more about reelection than the national interest, politicians from Nagatacho reigned but did not rule. Instead, they acceded to bureaucrats’ control over large swaths of policy-making authority. The result has been a body of literature emphasizing the strength of the bu­ reaucracy and, concomitantly, deemphasizing political accountability.1 In gen­ eral, they gave the bureaucracy the appearance of power without limitation. To the extent that they acknowledged constraints, commentators mentioned them briefly and grudgingly. They were often internal, arising not from the political process, but from rivalry and disunity within the bureaucratic community. In fact, however, the bureaucracy, for all of its power, exists within a highly charged, highly political environment. The ties between politicians and bureau­ crats involve a web of family, school and other connections. Personal connec­ tions also abound, with marriages and dynasties linking the two groups. Politicians have a much larger, albeit often more subtle, impact on the bu­ reaucracy than is conventionally accepted. Politicians establish limits. Sudden shifts in policy must receive their approval, implicitly or explicitly. A constant process of consultation occurs between bureaucrats and politicians. While ad­ ministrative promotions are normally left to the bureaucracy, they do not occur

Overthrowing the Past

5

in a vacuum, unmindful of the political environment. Indeed, they are only announced after important politicians have been given a chance to influence the process. Within that environment, the bureaucracy serves at least two critical political functions. Foremost, it acts as an arbiter of disputes among relevant constitu­ encies. Policy changes in any political system generate winners and losers and often require some degree of compromise. Yet by identifying with a particular side, politicians risk alienating the losing constituencies. Politicians effectively allow much of the conflict and inevitable compromise to occur at the bureau­ cratic level, thereby avoiding the need to participate directly in the process. Having said that, the consensus-building process undertaken at the bureau­ cratic level still occurs within parameters set by politicians. As the consensus develops, politicians are kept informed on a frequent basis. Bureaucrats know that constituencies unhappy with the resulting compromise could and would appeal to their allies within the political establishment. The threat of political intervention places greater pressure on bureaucrats to resolve matters in a man­ ner acceptable to all interested parties. Nor is there anything wrong with bureaucrats rather than politicians facilitat­ ing consensus development, assuming one is required. The inherent problem with bureaucratic consensus building has not been the level at which it occurred but the exclusive nature of the process. For most of the postwar era, consensus was developed not among all important interest groups within the country but only among the constituencies important to the LDP. The result was a system that favored industry at the expense of consumers and other excluded groups. The bureaucracy plays a second critical political role. Politicians have con­ sistently supported the facade of bureaucratic power to provide cover whenever policies do not work or they harm important interest groups. Viewed as respon­ sible for particular outcomes, both good and bad, the bureaucracy effectively shields politicians from much of the resulting criticism and blame. The bureauc­ racy amounts to a scapegoat for matters more appropriately blamed on others. This suggests that politicians benefit from the role played by bureaucrats. As long as that continues, structural shifts in the relationship are unlikely. In fact, despite criticism and dissatisfaction with the bureaucracy, politicians in Japan indicate little real interest in a fundamental change in the power structure.

Political Intervention and Reform The analysis suggests that many problems associated with the bureaucracy have a political explanation. Moreover, the close connection with politicians provides an often ignored source of change. So closely connected are the two groups that as the interests of politicians change, so will the practices of the bureaucrats. Bureaucratic sensitivity to political concerns amounted to a relatively straight­

6

The Ministry of Finance

forward proposition during the period of one-party rule. At least since Kukuei Tanaka served as prime minister, the bureaucracy paid little heed to opposition parties. There was no risk that they would come to power and implement their policies. The bureaucracy, therefore, remained concerned only with the policies and constituencies of the LDP. Given the factionalized nature of the LDP, this was not always a simple proposition. The bureaucracy did have to remain aware of shifts within the mling party. The task, however, was not excessively difficult. Factions tended to re­ volve around personalities rather than significant policy differences. And, with only one party and a consistent set of constituencies, bureaucrats had a relatively easy time discerning the parameters of their decision-making authority. All that has changed. The LDP no longer has a monopoly on power. Oppo­ sition parties cannot simply be ignored; they may actually come to power. The emerging multiparty system will likely cause considerable change in political goals. In addition to a viable opposition, electoral reform has also permanently al­ tered political dynamics in Japan. The shift from multimember to single-member districts has forced politicians to seek support from nontraditional interest groups. Politicians, even those within the LDP, can no longer be elected by focussing on a small number of interest groups that will ensure their place among the leading candidates. Politicians will therefore need to appeal to con­ stituencies outside the historical groups coddled by the LDP. This will generate a genuine competition for votes and a greater emphasis on electoral accountability. Shifts in demographics and an erosion of the postwar consensus favoring economic growth will also provide some impetus for polit­ ical change. As political behavior changes, so will the behavior of the bureauc­ racy. The bureaucracy will become more responsive to the new dynamics. The clearest manifestation will be the expansion of the groups involved in the con­ sensus-building process. Perhaps the biggest problem with bureaucratic policy making in the postwar period has been the limit on the groups that participated in the consensus­ building process. With bureaucrats concerned primarily with traditional constit­ uencies of the LDP, certain groups such as consumers had no direct role. In fact, bureaucrats in the MoF took the position that they were the middle class and therefore had no need to turn to specific groups representing their interests. Policies that emerged from the consensus-building process were fundamen­ tally pro-business and, as a consequence, anti-consumer. Thus, in the financial arena, the convoy system, which involved bureaucratic protection of the weakest financial institutions, kept all banks compartmentalized, largely preventing com­ petition through innovative practices and lower-cost services. The result was a banking system that did not promote the interests of con­ sumers. Consumers had to accept anemic interest rates on their deposits. Little attention was paid to their borrowing needs, with conventional credit cards una­ vailable until the 1980s. Accounts at the largest commercial banks were hard to

Overthrowing the Past

7

open and personal loans often unavailable. ATM machines, an obvious conven­ ience, saw their hours of operation limited to protect those banks that could not afford their installation. The anti-consumer policies emanating from the bureaucracy had a fundamen­ tally political explanation. With the Socialists never a threat to take power, politicians had less interest in competing for new voters and more interest in appeasing existing constituencies, particularly those important in financing elec­ tion campaigns. Unsurprisingly, therefore, bureaucratic policies mimicked these political biases, with efforts concentrated on support of interest groups important to the LDP. As political interests change, however, so will the policies of the bureaucracy. In a more competitive era, consumers and other historically excluded groups are becoming more important to politicians. As a direct result, the bureaucracy will begin to find room for them in the consensus-building process. Bureaucrats will continue to resolve disputes and forge a consensus where necessary. They will do so, however, in a more inclusive fashion. Bureaucrats will do so because the alternative is unacceptable. To the extent they prove unwilling to reflect the new dynamics, they will invite political in­ tervention, something bureaucrats loathe. Where disagreements between politi­ cians and bureaucrats have arisen, politicians have gotten their way. The LDP has interfered with MoF personnel matters on a number of recent occasions, including the early dismissal of an Administrative Vice Minister and the ap­ pointment of Eisuke Sakakibara as International Vice Minister. On other occasions, politicians have insisted on policy changes over the ad­ amant opposition of bureaucrats. The MoF opposed increases in public works spending in the 1970s, defense spending in the 1980s and agricultural spending in the 1990s. Politicians simply disregarded the opposition and ordered imple­ mentation. Overt political intrusion has been viewed by bureaucrats as anathema. The myth— one that they foster— is that bureaucrats control politicians, not the other way around. Bureaucrats regularly speak with disdain about politicians. More­ over, while bureaucrats prize political connections and effectiveness, any indi­ cation of excessive political influence will generate a visceral reaction, with officials too closely associated with particular politicians finding themselves in­ tentionally passed over for promotion. The desire to avoid political intervention represents a self-correcting mecha­ nism that will generate change in bureaucratic behavior. Interference can only be avoided where political interests and bureaucratic practices coincide, thereby rendering intervention unnecessary. In other words, the bureaucracy can remain independent only by fully embracing the goals and interests of politicians. As bureaucratic practices evolve and the consensus process broadens, the role of the bureaucracy will seem unchanged. Politicians will continue to do what they do today: more or less rubber stamp the end result negotiated by the bu­ reaucracy, adopting it without change. They will do so, however, because bu­

8

The Ministry of Finance

reaucrats employed a more inclusive consensus-building process involving a broader segment of the Japanese population. THE INFLUENCE OF MARKET FORCES Not all of the changes in bureaucratic behavior will emanate from politicians. As the economy changes, practices within the bureaucracy cannot remain static. The existing approach to regulation worked in the postwar system but is no longer suited to an economy more reliant upon market forces. A more marketdriven economy means reduced bureaucratic involvement in economic decision making. While bureaucracies universally despise relinquishing authority, the process is well underway. The critical mechanism inducing bureaucratic change is the desire to avoid embarrassment and the concomitant loss of public stature. Unelected, the bu­ reaucracy remains influential in large part because of the view among the public that it has the technical expertise to manage and that it acts in the best interest of the country as a whole. Public embarrassment weakens the status of the bureaucracy by dispelling the myth that bureaucrats are the only ones with the skills to properly manage matters. Loss of stature also makes it harder to attract the best and the brightest to a bureaucratic career. When Japan had a relatively small economy essentially closed to foreign influences, bureaucrats could make decisions confident of achieving the desired result. Funds could be directed to the proper industries. The cost of money could be kept artificially low. If the stock market fell too far for comfort, bureaucrats could resucitate demand. The belief that bureaucrats could stage-manage events generated practices that would ultimately become counterproductive, most notably the excessive predi­ lection for secrecy. Only bureaucrats needed to know the true state of affairs. Publicizing the full extent of the problem might result in a destabilizing loss of confidence by the public and was therefore not done. The days of bureaucratic control are, however, gone. The economy has be­ come too large, susceptible to too many influences, many from international sources. Bureaucrats tried but failed to control the stock market following the dramatic drop in the early 1990s. They tried to micromanage the activities of banks, only to become embroiled in the country’s worst financial crisis since the occupation. Close relations with securities firms resulted in bureaucrats turn­ ing a blind eye to fundamentally unfair practices that erupted into the compen­ sation scandals. Continued insistence on approving new financial products caused business to flow to other international markets. The result has been constant embarrassment. In these instances, bureaucrats have gradually learned painful and very public lessons. They simply lacked the ability and, given their lack of practical experience, the expertise, to control events. Efforts to do so only made things worse. Having tried to control events, they were blamed when they failed. Probably more than any single factor, the

Overthrowing the Past

9

MoF’s continued insistence that it could dictate results in the financial markets while failing ignominiously to do so caused the Ministry’s widespread public pillorying. The fear of embarrassment has and will continue to affect bureaucratic be­ havior. The MoF will learn to avoid intervening in, and taking responsibility for, events it cannot control. In part, this will mean leaving to industry respon­ sibility for certain areas, particularly those related to consumers (both corporate and retail). In part it will mean a greater willingness to dispense with secrecy as a method of conducting policy. In fact, a new, hands-off more open approach has already become discernible in the regulation of retail banking, the introduc­ tion of derivative products, and the bailout of insolvent financial institutions. THE MINISTRY OF FINANCE In analyzing the evolving role of the bureaucracy in the transformed economy, this book will focus on the Ministry of Finance. An obvious candidate for study, the MoF rests at the pinnacle of a powerful administrative system. The Ministry has responsibility for, among other things, formulating the government’s budget, overseeing the financial markets, assessing and collecting taxes and customs duties, supervising insurance companies, and handling foreign exchange matters. Even the Bank of Japan (BoJ), the country’s central bank, remains beholden to the powerful Ministry. For all of its power, the MoF has remained a bureaucracy acutely aware of the political environment. The Ministry continues to send more former bureau­ crats to the Diet than any other ministries. Policies are developed with political parameters in mind. The fact that politicians rarely intervene overtly in Ministry affairs reflects less the bureaucracy’s power and more its political acumen. These matters, however, are in flux. The change in the postwar political struc­ ture and the unprecedented economic slowdown of the early 1990s has disrupted traditional patterns. The MoF has had to weather embarrassing scandals, admin­ istrative reorganizations and political intervention. Nonetheless, for all of the upheaval, the MoF remains at the center of the budget-writing process and is still the primary regulator of the financial markets. The Ministry of Finance and the Political Process Of all the Japanese bureaucracies, the MoF has gone to the greatest lengths to emphasize its independence from the political process. Indeed, resistance to political intrusion is ingrained in the MoF’s bureaucratic psyche. Ministry of­ ficials often express disdain for politicians and see themselves as the guardians of the national interest. It is the mandarins in the MoF who ensure the country’s fiscal health. Bu­ reaucrats in the Ministry have an almost immutable adherence to fiscal conser­ vatism, particularly an attachment to the concept of balanced budgets. This

10

The Ministry of Finance

position in large part amounted to a weapon used to restrict the discretion of the spendthrifts in the Diet. Only by rigidly adhering to the goal of a balanced budget could they restrain the self-interest and the profligate spending habits of politicians. The MoF also views itself as the guardian of the financial markets. Reform proposals emanate from the MoF, in consultation with affected industries. The MoF, not the Diet, originates and drafts relevant legislation. The Ministry, not the politicians, arbitrates most of the disputes among competing interest groups and forges the consensus necessary to ensure approval of any reforms. Politicians have little public role in the process. Finance ministers are ex­ pected to support the policies of the bureaucracy rather than impose their own. They do not overtly interfere in personnel decisions. Career officials within the Ministry, in conjunction with retired bureaucrats (the “ Old Boys” ), determine who becomes director general of a bureau or administrative vice minister. Despite the appearance of independence, however, the MoF remains one of the most, if not the most, politicized of ministries in the Japanese bureaucracy. In particular, control over the budget dictates almost continuous interaction with politicians. Allocating government revenues, locating funds to prime the econ­ omy, raising additional amounts through deficit spending— all these functions involve political decisions, something the MoF cannot undertake alone. Moreover, the entire budgetary process is replete with political influence. Spending priorities have shifted as political needs have changed. During periods of slow growth, the MoF was pushed into using deficit spending and expan­ sionary budgets. Bureaucrats had no choice but to accept income tax cuts, some­ thing that would cause deficits to skyrocket. They did not do so volitionally, but because politicians insisted. Similarly, oversight of the financial markets has required actions and decisions that could only take place within politically established parameters. The tech­ nical aspects of financial reform tended to generate only modestly overt political interest. While politicians received a steady stream of information about signif­ icant reform efforts, they avoided direct interference in the consensus-building process. They were more than willing to accept the compromises ultimately approved by industry participants. Politicians did intrude, however, when the MoF failed to obtain the requisite consensus, either among ministries or within the affected industry. The Diet, for example, had to arbitrate a number of interministry disputes between the MoF and the Ministry of Posts and Telecommunications. In the 1960s, a MoF-inspired bill designed to cement the Ministry’s control over the Bank of Japan went nowhere following vociferous opposition from the central bank. Perhaps more importantly, politicians represented a brooding presence. Bu­ reaucrats knew that politicians could intervene any time a particularly influential constituency was dissatisfied. No group of financial institutions had better con­ nections than those in the securities industry. Efforts to negotiate an end to the division between banks and brokers could not go forward as long as securities

Overthrowing the Past

11

firms objected. Only when they were humbled by scandal and their political support was gone did the MoF push through the final reforms. The arrangement amounted to an implicit agreement dividing the spheres of influence between politicians and bureaucrats. As long as bureaucrats could forge a consensus among all affected industries, politicians would not overtly interfere. If the MoF failed or pushed reform ahead too quickly, politicians stood ready to intervene. Maintaining bureaucratic independence, therefore, meant a sophisticated un­ derstanding of the reigning political goals. Despite their relative freedom, bu­ reaucrats were intensely aware of the political consequences of their actions. In the end, the MoF had relatively free reign only because it did a proficient job achieving a consensus without conflicting with the broad political goals of the LDP. All of this suggested that while both groups were usually partners in any effort to obtain reform of the financial markets or agreements on the budget, ultimate authority rested with politicians, not omnipotent bureaucrats. More than by rote statements about the structure of the Japanese government, important bureaucratic decisions were in fact made in a highly political environment with constant and significant political input. The political process rested at the top of the pyramid, with bureaucrats fully aware of the potential for intervention, mod­ ifying their behavior accordingly. This did not mean that the MoF amounted to a passive participant, doing only what politicians wanted. While those in power had the ultimate authority to dictate change, bureaucrats benefited from the factionalized nature of Japanese rule. The reigning political force, the LDP, often seemed less a single party than an amalgamation of independent parties, each with a titular head, a separate campaign organization, and its own source of funds. While the same party remained in power continuously from the 1955 until 1993, alliances among factions in the ruling coalition often shifted, with support depending less on substantive differences and more on the prospect of obtaining power. The Ministry could delay unwanted initiatives in the hope that the faction in power would change and the matter would slip into oblivion. The factionalized nature of the LDP, however, represented a double-edged sword. The MoF itself was no monolith, containing seven primary bureaus and a secretariat, each of which had a different regulatory bailiwick and constitu­ ency. Efforts were made to promote bureaucrats who had ties to or support from each of the LDP’s principal factions. The divisions could be and were used by politicians to manipulate the bureaucracy. The Future of the Ministry of Finance For much of the postwar period, the MoF’s role in controlling the budget process and the financial markets remained unchallenged. The Ministry was held in high esteem by the Japanese population, fully confident that it would act in

12

The Ministry of Finance

the country’s best interests. Despite the anti-consumer nature of many of the resulting policies, it was hard to argue with success. Everyone benefited from the high rate of economic growth encouraged by the MoF’s policies. In Japan today, however, the MoF’s reputation has taken a 180-degree turn. The MoF’s micro-management of the financial markets has become increasingly counterproductive. The Ministry seemed increasingly powerless in the face of market forces, with a 60% drop in the stock market and the collapse of property markets. Banks and securities firms rested on the edge of insolvency. In the budget area, the MoF has generally been seen as indifferent to the harmful consequences of the economic slowdown. The religion of fiscal con­ servatism resulted in a rote opposition to deficit budgets, even when economic conditions seemed to dictate otherwise. To make matters worse, ordinary Jap­ anese had to suffer the consequences of a weak economy while financial insti­ tutions affiliated with the Ministry of Agriculture, Forestry and Fisheries were bailed out. As a result, the MoF has come under an unprecedented degree of criticism. The Ministry has been subjected to harsh attacks, with even the LDP recom­ mending a breakup. Two administrative vice ministers have seen their tours of duty cut short. The Japanese press has collectively and viciously challenged the previously sacrosanct Ministry. The cumulative effect of these blows has caused the stature of the MoF to fall in the eyes of the public. No longer are these bureaucrats seen as omnipotent, capable of solving any economic or financial problem. No longer is it a foregone conclusion that they are the most appropriate guardians of the public interest. These developments would seem to suggest that the MoF’s days of unparal­ leled power are over. Even if staving off dismemberment, the MoF would not seem to command the respect or fear needed to remain at the top of the bu­ reaucratic pyramid. This book might, therefore, be more appropriately titled The Fall o f the Ministry o f Finance. In fact, however, the MoF has the capacity to maintain its powerful position in Japan. To do so will require fundamental changes in bureaucratic attitudes. Absent a new approach, the bureaucrats within the MoF will remain out of sync with a Japan undergoing an economic transformation. With some visionary lead­ ership and changes in the bureaucratic approach toward decision making, how­ ever, the MoF can succeed in maintaining its preeminent position. The MoF must become more pluralistic. Officials will cease to have an ex­ clusive relationship with the traditional constituencies of the LDP, something necessitated by the emergence of true political alternatives. Not knowing who will hold power in the future will force the MoF to improve relations with other parties and other constituencies. This will necessarily mean a broader approach toward policy formulation and a greater consideration of policies favored by viable opposition parties. The Ministry will also need to get its own house in order. Internal reform must occur. Circumstances change too quickly and markets are too complex for

Overthrowing the Past

13

the traditional approach toward regulation. The absence of expertise in financial markets is no longer acceptable. Finally, the bureaucratic habit of avoiding re­ sponsibility and hiding from risk will need to be jettisoned, with increased em­ phasis on accountability. The recognition is also growing that excessive secrecy is counterproductive. Matters have a way of inopportunely leaking to the public, causing a loss of credibility that more than offsets the negative consequences of open disclosure. Efforts to keep the trading losses by Daiwa Bank quiet produced disastrous results and damaged relations with the United States. Tolerating nondisclosure of bad loans contributed to the first post-occupation run on a bank in Japan and damaged the credit-worthiness of the entire financial system. While not yet ready to abandon the attachment to secrecy, the MoF has learned that in at least some instances nondisclosure has done far more harm than disclosure. Meeting the needs of politicians and accepting the loss of authority that comes with greater deference to the market must occur for the bureaucracy to survive in a strong and influential position. To the extent that it resists, politicians will have no choice but to seize the decision-making power; domestic industries will have no choice but to increasingly disregard bureaucratic edicts and move ac­ tivities outside of Japan. The likely evolution of bureaucratic practices has significant policy ramifi­ cations. The focus of reform should be less on breaking apart the Ministry and more on internal changes that will encourage a less status quo approach to regulation. Some of that will occur naturally, as bureaucrats reach out to other constituencies. Other changes will have to be more deliberate, with the goal of creating an environment that makes the bureaucracy less risk-averse. That is not to say that the process will be smooth or automatic. If the MoF is any kind of example, it is clear that discarding the old ways will come slowly, only after the bureaucrats have realized, through political conflict and public embarrassment, that they have no choice. Developments currently taking place suggest that the MoF is learning that lesson. Yet if the Ministry wants to retain its preeminent position it will need to change even more. In the MoF’s own words, the time has come to “ restructure or die.”

CHAPTER 2

Inside th e M inistry of Finance

Tucked among the gray buildings in Kasumigaseki, the section of Tokyo hous­ ing the government bureaucracy, rests a dowdy five-story building built in 1943.' Over the tattered carpet and warped parquet, past offices stacked with papers and full of green metal desks (although now often with a computer), the unas­ suming structure contains by most accounts the most powerful bureaucracy in the industrial world: the Ministry of Finance or, simply, the MoF. Founded in 1869, just after the Meiji restoration, the MoF represents one of the oldest bureaucracies in Japan. Its strength arises in part from the broad turf under its supervision. The superbureaucracy drafts the general account budget for the entire Japanese government, negotiating spending ceilings with the other ministries. That alone would make the MoF a force to be reckoned with. The MoF’s authority, however, goes much further. The Ministry has respon­ sibility for regulating banks, securities firms, mutual funds and insurance com­ panies; for developing tax policy and regulating foreign exchange; and for raising government revenue, whether from taxes, government bonds, or customs. In short, the entire system of public and private finance falls within this super­ bureaucracy’s bailiwick. Having the power would mean little without the skills to use it effectively. The MoF exercises its authority through a small cadre of about 800 career officials. They are by any measure a remarkable group of people. Typically graduates of the law faculty at the University of Tokyo, they represent the “ elite of the elite.” Extraordinarily bright, superbly trained, wearing identical suits (except for those in the International Finance Bureau), sometimes arrogant, they represent the heart and soul of the powerful bureaucracy. Career officials who join the MoF in a particular year advance in lock-step. They tend to be promoted at the same time to the same level. Seniority repre-

18

Bureaucratic Practices

sents a critical component of the process. Moreover, officials typically hold positions for only a year or two, rotating in and out of the major bureaus within the MoF or other ministries. These practices have given rise to a number of myths about the MoF. Because bureaucrats hold positions for relatively brief periods, the MoF is said to educate generalists, with officials never obtaining an adequate expertise over the sub­ stantive areas they supervise. Moreover, short terms at the highest levels make policy innovations all but impossible. These qualities cause many to conclude that the MoF promotes the status quo and is incapable of dramatic change. Officials lack initiative and creativity and instead are bound by their bureaucratic philosophy of fiscal conservatism, no matter what the state of the economy. Moreover, with the bureaucracy encour­ aging conformity and discouraging initiative, the situation is not likely to change. While these attributes have a modicum of truth they are overly broad to the point of inaccuracy. It is, for example, incorrect to state that the MoF educates only generalists. Some of the areas under bureaucratic oversight require and receive specialized training. The Tax Bureau represents the best example. Those heading the Bureau typically spend their entire career dealing with tax issues. It is also not the case that the MoF rotely adheres to the status quo. In fact, the MoF has shown itself quite capable of dramatic change. The Ministry almost single-handedly balanced the budget in 1990, although economic growth and increased tax revenues played an important role. It revamped the tax system, shifting the tax base from direct to indirect. In the financial markets, the MoF engineered the abandonment of the postwar compartmentalized financial system. Having said that, the MoF does have a number of bureaucratic attributes that hinder change. Rapid rotation raises concerns. Short tenures have become a mechanism for avoiding risk. Aware that they will rotate shortly, officials often do not address difficult or controversial decisions, leaving the matter for a suc­ cessor. Nor does the bureaucracy adequately reward initiative. Those willing to han­ dle difficult matters or make hard decisions do not necessarily see their careers enhanced. While merit matters, bureaucrats reaching the top of the Ministry often succeed by avoiding controversy and scandal and demonstrating strong consensus-building qualities.

THE BUREAUCRATIC FRAMEWORK The MoF contains a relatively clear hierarchy. The finance minister rests at the top of the pyramid and is the only political appointee of any significance.2 Below the minister, the two highest ranking career positions are administrative vice minister and vice minister for international affairs. Next are seven bureaus, each overseeing a separate substantive area. The bureaus are further divided into

Inside the Ministry of Finance

19

divisions, each with a particular specialty. The MoF also has a Secretariat, pri­ marily responsible for the administrative matters within the Ministry. Finance Minister The minister, a politician, is the highest ranking MoF official. The minister constitutes the only significant political appointee, a situation contrasted with the United States where the president appoints the entire upper echelon of the bureaucracy. One of the most important cabinet posts, finance ministers routinely go on to become prime minister. Usually concerned with taking the next step on the political ladder, finance ministers traditionally serve for relatively short periods and rarely become di­ rectly involved in the MoF’s routine affairs. This has given rise to the myth that finance ministers act as marionettes for the bureaucrats, not exercising leadership but simply parroting the Ministry’s position. In fact, the MoF has often been led by politicians who got their way with bureaucrats. Moreover, some, such as Hayato Ikeda and Takeo Fukuda, served in the position more than once, long enough to establish their will over the bureaucracy. Unsurprisingly, therefore, finance ministers who later rise to the top of the political structure have often proved adept at managing the MoF. Powerful finance ministers have used their tenure as an opportunity to develop supporters within the Ministry. The finance minister takes two administrative aides from the Ministry bureaucracy. The posts provide both sides with an op­ portunity to build alliances and influence. Ikeda constructed a particularly strong network, although as an MoF alum, he had the benefit of developing support during his tenure in the Ministry. Administrative Vice Minister Beneath the minister is the vice minister of administrative affairs or jimu jikan, the highest-ranking career post. Serving one or at most two years, this official supervises the activities of the entire Ministry.3 The relatively short term has a bureaucratic explanation. A one-year term allows an official from each entering class to have a turn at the highest ranking position. Longer terms essentially displace classes, a step undertaken hesitantly. Officials who have become jikan generally follow a predictable mainstream (honryu) career path through the Ministry. With few exceptions, jikans in the postwar era have graduated from the University of Tokyo (Todai), ranked at the very top of the National Exam, and held certain critical positions within the Ministry. Vice ministers are generally promoted from the head of the Budget Bureau, the most powerful subdivision within the MoF.4 Exceptions occasionally occurred but they tended to have specific explana­ tions. In the postwar era, only one administrative vice minister did not receive his education at Todai. Hayato Ikeda came from Kyoto University, an anomaly

20

Bureaucratic Practices

explained by wartime exigencies.5 Vice ministers also occasionally came from the Tax Bureau and four times since the war’s end were promoted out of the Banking Bureau, most recently in 1989.6 They have twice been appointed from the National Tax Agency Administration, although both occurred in the volatile 1990s,7 and once from the Office of the Cabinet Councillors.8 These deviations from the mainstream did not occur often and were viewed as exceptions. Perhaps the most critical function of the administrative vice minister is to make personnel decisions. The jikan spends a great deal of time influencing the critical system of rotation within the MoF. This includes the designation of his own successor and the negotiation of the appointment with key politicians. Vice ministers, however, do not have unlimited authority in the area. They make major personnel decisions in conjunction with others in the Ministry, particularly the head of the Secretariat and the division director of the Personnel Section (hisho kacho). In addition, they will consult with their predecessors. Not all former vice ministers will be asked for an opinion. The most influential include the group commonly known as the “ Old Boys,” retired vice ministers who continue to have considerable residual influence. The “ Old Boys” provide advice on im­ portant promotions and post-retirement positions such as governor of the Bank of Japan and head of the Tokyo Stock Exchange (TSE). Vice Minister for International Affairs The vice minister for international affairs, or zaimukan, represents the highestranking international officer within the Ministry. This official has responsibility for international financial policy and attends the principal economic meetings and summits. Sometimes known as a “ barbarian tamer,” the Vice Minister for International Affairs must manage foreign influence and present Japan’s views to the international community. Most flow charts of the Ministry would place the office directly under ad­ ministrative vice minister, suggesting that the position is the second most im­ portant. Doing so would, however, give a deceptive impression. The position was created to provide parity at international meetings and, while the post of zaimukan has grown in importance, it lacks the power and importance of ad­ ministrative vice minister or heads of the major bureaus. Existing briefly after the war, the post was eliminated in the 1950s. The absence of a high-ranking international position, however, left the MoF at a diplomatic disadvantage. Most countries sent an undersecretary or the equivalent to international summits. The lack of a comparable position in Japan proved an embarrassment. The MoF could only muster the director general of the Inter­ national Finance Bureau, an important but lower-ranked official. The resurrection of the zaimukan position in the late 1960s provided the MoF with an equivalent to an undersecretary and, therefore, parity at international meetings. In a unique sense, the creation of the position represented an early

Inside the Ministry of Finance

21

example of the role that foreign considerations played in influencing the MoF. But for international ramifications, the position probably would not have been resurrected. The creation also had a more personal explanation, allowing the MoF to promote and keep for a while longer Yusuke Kashiwagi, the influential head of the International Finance Bureau. Given the external purpose of the position, the zaimukan originally had little involvement in domestic matters. The official was generally expected to defend Ministry policies in international fora. In fact, a substantial portion of the zai­ mukan's term was spent preparing for, or attending, international meetings. That changed in the 1980s with the dramatic increase in foreign pressure, particularly from the United States. As the United States sought reform of Jap­ anese financial markets, it fell to the zaimukan to manage the intrusion. The international vice minister had the relationships with, and understood the per­ sonalities of, U.S. Treasury officials, something that played an important role in the almost continuous negotiations that began in the 1980s. Tomomitsu Oba is generally credited as the zaimukan who substantially en­ hanced the status of the post. Appointed in 1983, he headed the MoF’s team in negotiations with the U.S. Department of the Treasury that culminated in the Yen-Dollar Accord. Oba deftly used U.S. pressure to force change on some of the most provincial bureaus within the MoF and in the domestic markets. The result was liberalization of the banking system, the government bond syndicate, and the euroyen market. The evolution in the importance and nature of the international vice minister could be seen from the change in the appointment process. Initially, no particular bureau monopolized the position, nor had the appointee necessarily received much specialized training in international matters. Instead, the position went to the runner-up for administrative vice minister, a consolation prize of sorts. Early recipients, therefore, came from a variety of bureaus. As the post became increasingly important and involved in sensitive inter­ national matters, the practice emerged of elevating the director general of the International Finance Bureau to zaimukan. The change reflected an internal de­ cision within the MoF that the person appointed to the post should have con­ siderable international experience and fluency in English. At the same time, however, the mainstream for those heading the International Finance Bureau was to include some experience in other, more domestic, bureaus, particularly Tax and Budget. This was designed to prevent the position from becoming isolated from the domestic functions of the MoF.9 The Bureaus Beneath the two vice ministers, the MoF has seven primary bureaus, each headed by a director general, or kyokucho, and a secretariat, headed by a direc­ tor. The bureaus until recently included Budget, Tax, Treasury, Banking, Se­ curities, International Finance, and Customs. Reforms implemented in the

22

Bureaucratic Practices

Z a im u k a n

P e n u l ti m a t e P o s t

E n try

Z a im u k a n

E is u k e S a k a k ib a ra

I n t’l F in a n c e D G

1965

1997

T a k a to s h i K a to

In t’l F in a n c e D G

1964

1995

K o s u k e N a k a h ira

I n t’l F in a n c e D G

1963

1993

T a d a o C h in o

I n t’l F in a n c e D G

1960

1991

M a k o to U tsu m i

In t’l F in a n c e D G

1957

1989

T o y o o G y o te n

I n t’l F in a n c e D G

1955

1986

T o m o m its u O b a

In t’l F in a n c e D G

1953

1983

K iic h i W atan a b e

T re a su ry B u re a u D G

1950

1981

T a k e h iro S a g a m i

S e c re ta ria t D G

1948

1978

M ic h iy a M a ts u k a w a

T re a su ry B u re a u D G

1947

1976

T a ro ic h i Y o s h id a

B a n k in g D G

1944

1974

K o ic h i In a m u ra

In t’l F in a n c e D G

1943

1973

T ak ash i H osom i

T ax D G

1942

1972

Y u su k e K a sh iw a g i

In t’l F in a n c e D G

1941

1969

summer of 1998 combined the Securities and Banking bureaus into a single Financial Planning Bureau. The bureaus fall into two broad categories: (1) those connected to the budget process, including public finance, and (2) those involved in regulating the financial markets, including banks, securities firms, investment funds and insurance companies. The MoF also contained two semi-autonomous organizations, the National Tax Agency Administration, primarily responsible for revenue collection, and, until combined with the Financial Supervisory Agency in 1998, the Securities and Exchange Surveillance Commission, primarily responsible for enforcement activities in the securities markets. The director general of a bureau typically serves a one, maybe a two-year term, although longer ones are possible. Masaru Mizuno served as director gen­ eral of the Tax Bureau for more than three years, primarily to ensure passage of the consumption tax. Sadaaki Hirasawa served for three years as director general of the Banking Bureau, with the extra time used to complete reforms designed to liberalize the financial markets. In each instance, the director general remained in place long enough to complete an assigned task. Beneath the position of director general are deputy directors general, with the number depending upon the particular bureau. Bureaus are further divided into divisions, each with a director (kacho) and deputy directors (kacho hosa). Roughly in between are senior assistant directors (kikakukan), with responsibility for coordinating the activities of the deputy directors. Those within the Ministry generally oppose efforts to rank the bureaus. None-

Inside the Ministry of Finance

23

theless, a clear order exists. Budget represents the most powerful. From a do­ mestic perspective, few things matter more than allocating public funds. With a few anomalous exceptions, all directors general of the bureau have been pro­ moted to administrative vice minister. Moreover, most significant policy changes engineered by other bureaus inevitably have some impact on budgetary matters. Internally within the MoF, therefore, the Budget Bureau has some say in, and the power to veto, almost any action of the Ministry. Second in line is Tax. The Tax Bureau masterminded the country’s shift away from direct (income) to indirect (consumption) taxes. The Budget Bureau aside, Tax has produced the most administrative vice ministers in the postwar era. The bureau also has a reputation as the most parochial, opposing any tax change that reduces revenues. The Secretariat is another important office. Anyone becoming vice minister must have some experience in the Secretariat. The Secretariat has control over administrative matters in the MoF, particularly personnel matters. The Secretar­ iat hires the new class of career officials, decides on new assignments for ro­ tating bureaucrats, and finds positions for those retiring. In addition, the Secretariat has the most sustained contact with politicians. The financial bureaus are not considered as important as those involved in the tax and budget process. Of the three bureaus, only one has directly produced administrative vice ministers. In the postwar era, four directors general of the Banking Bureau have risen to the highest bureaucratic position.10 In each in­ stance, however, they were officials in the mainstream who were rerouted to the bureau to perform specific tasks. The Securities Bureau, in contrast, has traditionally been viewed as a secondclass bureau, in part because it was the newest and in part because it regulated an industry generally held in low regard by the mandarins of the MoF. The low status of the bureau ultimately contributed to excessively close relations with the securities industry and led to the first significant financial scandal to engulf the MoF in the 1990s. Despite residing under one roof, the bureaus act in a highly independent fashion. Sometimes described as balkanized, they compete with each other for power and influence. High-level officials from the different bureaus rarely meet collectively. The only time the bureaus act in a truly united fashion is to support the budget. When U.S. negotiators met with their Japanese counterparts in 1983 and 1984 to negotiate over financial reform, the principal bureaus participated in the talks. U.S. officials were told that it represented the first time in memory that the upper echelon of each bureau participated in a collective endeavor. All of this means that the MoF is no monolith. The Ministry often contains sharp divisions and a multitude of opinions on various issues. In the 1990s, dissension was particularly severe between officials in the financial bureaus and those in the Budget Bureau, something which exacerbated following Jiro Saito’s tenure as administrative vice minister. Once a consensus emerges, however, the disharmony disappears. The MoF speaks with one voice, something that encom-

24

Bureaucratic Practices

passes both existing and former officials. High-ranking former officials, the “ Old Boys,” are expected to toe the bureaucracy’s line and even to be mouth­ pieces for Ministry pronouncements. Thus, despite a fierce internal dispute, the Banking Bureau’s decision to seek public funds to bail out the housing loan companies or jusen ultimately received unified support within the MoF. ENTRY AND ADVANCEMENTS The MoF oversees financial and budgetary matters with a relatively thin career staff. The Ministry accepts only a small number of new career officials each year. Equally noteworthy, they come directly from university. The MoF does not accept laterals or persons with private-sector experience.11 As a result, career officials in the Ministry have no practical experience in the areas they oversee. The MoF traditionally accepted a new class of 20 to 25 graduates each year. The number would vary as circumstances dictated. The class of 1929 contained only seven while classes accepted during the occupation climbed as high as 50, twice the usual number. In recent years, however, the decision to downsize the bureaucracy has resulted in smaller classes. The class of 1997 had 19 members; the class of 1998 only 17. Conventional wisdom has it that career officials are chosen from their scores on the Level I Entrance Examination for National Public Service. In fact, that is not true. The primary selection method is personal interviews, with the last usually conducted by the chief of personnel (hisho kacho) within the Secretariat. Offers are made to prospective candidates before they are aware of their final results on the Public Service Examination. In identifying prospective candidates to interview, the MoF relies on faculty recommendations, grades and, to some extent, the score on the entrance examination for the University of Tokyo. Because the score on the entrance examination is a reliable predictor of the score on the Public Service Examination, MoF officials have a good idea of how candidates will do even in the absence of actual test results. Nonetheless, in at least a handful of cases, candidates accepted by the MoF have done poorly on the Public Service Examination. The year Eisuke Sakakibara, the zaimukan appointed in 1997, took the examination, he had the second lowest score of all test takers who passed. Graduates invariably come from the University of Tokyo, orTodai, and, more specifically, the law faculty. The MoF today takes only a token number of graduates from other schools or other Todai faculties, with one or two typically coming from the economics or science/math faculties. Of the 24 graduates en­ tering the Ministry in the spring of 1992, 22 came from Todai. In 1998, by contrast, only eleven of the 17 members came from the University of Tokyo, the smallest number since 1973. Career officials are also typically and overwhelmingly male. Among career staff, women were routinely accepted only in the late 1970s. In 1989, the MoF had only six women among its career staff. When one female candidate in 1996

Inside the Ministry of Finance

25

decided to interview at ministries that had hired at least two women in each of the previous five years, the MoF was not on her list. The class of 1997, with 19 members, contained one woman; the class of 1998 contained two, the most since 1965.12 Few women have obtained elevated positions within the Ministry. A woman only became kacho or division director for the first time in 1989 when she was appointed to head the Second National Property Division within the Treasury Bureau. That was surpassed in 1993 when a woman obtained the rank of deputy director general. High-ranking positions for women, however, remain rare. In 1997, only one woman held the post of kacho or division director, with Mariko Fujii serving as the director of the International Affairs Division of the Customs Bureau. In addition to career employees, the Ministry has another 75,000 or so non­ career officials. These are individuals who take a lower-ranked test. Despite their secondary status, non-career officials have a number of critical roles within the Ministry. They tend to remain in a particular bureau or even division for their entire career. Sometimes referred to as human encyclopedias (iki-jibiki), they provide much-needed expertise and continuity, particularly as career officers rotate in and out of various posts. Theoretically, they can rise to relatively high levels within the Ministry. In reality, however, non-career officials have little upward mobility. A few may reach the level of division director or kacho, but rarely higher. The highest position achieved by a non-career official is director general of the Printing Bureau. In general, non-career officials do not socialize with the highest Ministry officials, eliminating the personal contact so critical to advancement within the bureaucracy. Career officials follow a relatively preordained path. During the first year, they are assigned to a research or planning section in one of the bureaus. Choice assignments include posts in the Secretariat and Budget Bureau. Many spend a good part of the first year collecting information from opposition politicians about the questions they will ask in the Diet session, a quick and early intro­ duction to the political process. The MoF is the only ministry that turns this task over to new recruits. The process can be grueling, time-consuming (the Diet session lasts for 150 days), and involves long days. More than any other bureaucracy in Japan, the MoF has recognized the grow­ ing impact of internationalization and sought to address the trend. As a result, most bureaucrats are sent abroad sometime in the first several years to obtain an advanced degree, with the United States and Great Britain the most common destinations. While the MoF has long had a tradition of sending some junior officials abroad, the percentage in recent years has increased significantly. More­ over, growing numbers of mid-level officials have also been sent overseas. Those officials sent to study abroad typically remain for two years, although exceptions exist. While theoretically able to engage in any course of study, in Practice, career officials obtain degrees in law, economics or political science.

26

Bureaucratic Practices

While the experience contributes to an official’s substantive knowledge, the true reason for the program is to improve the foreign language capacity of MoF bureaucrats. Upon return to the MoF, officials assume the position of sub-section chief (kakari-in) and, a year later, section chief (kakari-cho). In approximately the sixth year, an official is appointed chief of a local tax office, a position viewed with considerable anticipation. Designed primarily to teach supervisory skills, the post involves interaction with the local community, which ordinarily rolls out the red carpet for officials who may be in a position to provide benefits in the future, and the promotion of the interests of the non-career employees in the office. Officials make it to the more elevated and influential position of deputy director or kacho hosa of a division within the bureaus sometime in their mid30s. Assistant budget examiners or shusa have the same rank as deputy directors. After serving as deputy directors, officials become kikakukan or senior deputy directors. They serve in the position for several years before becoming a direc­ tor. Division directors (kacho) within a bureau or budget examiners (shukeikan) in the Budget Bureau represent positions of considerable importance. Not all directors are equal. The most important include the head of the Documentation (bunsho ka) or the Personnel Section (hisho ka) in the Secretariat or the coor­ dination section (somu ka) within each bureau. They not only are critical posi­ tions to hold for continued advancement but also come with greater creature comforts. The kacho of the most important sections receives a private car, office and secretary. Among other things, a kacho spends considerable time with politicians. Dur­ ing Diet sessions, finance ministers are constantly questioned by opposition pol­ iticians. MoF officials work late into the night drafting answers to presubmitted queries. The section chief then meets with the finance minister to explain the answers. The questioning and briefing occurs often, sometimes daily, and suc­ cessfully monopolizes a considerable portion of the kacho’s time, at least while the Diet is in session. Senior officials often spend at least one significant tour outside the head­ quarters in Tokyo. Many obtain positions in bureaucracies “ colonized” by the MoF, with the Auditing Agency an example. External posts include those in the Economic Planning Agency, the National Personnel Authority and the Manage­ ment and Coordination Agency. Another important post is to serve as aide to the Finance Minister. Senior officials usually return as a shingikan, or deputy directors general.13 These are posts held by directors-general-in-waiting. They will be promoted to director general or exit the Ministry. Although technically in the Secretariat, shingikans are assigned to a particular bureau and substantive area. They convey information to Diet members in an effort to convince them of the MoF’s views. The function has, however, a manipulative feature. Shingikans control the in-

Inside the Ministry of Finance

27

formation flow, providing only what the MoF decides Diet members should know. With a limited number of bureaus, not all members of a class can obtain the rank of director general. Once promotions are announced, the remaining mem­ bers of the class quit en masse. The administrative vice minister will eventually be the only person remaining from a particular entering class and will have the longest service of any bureaucrat within the MoF. Often described euphemistically as “ one year, one job,” officials constantly rotate in and out of bureaus throughout their careers. Positions traditionally change each summer. Although often officially announced in June or July, To­ kyo is rife with speculation much earlier, with leaks about the new promotions sweeping through the private sector. Banks, securities firms and insurance com­ panies scramble to get matters approved before the reshuffle. Once the rotation occurs, the approval process often grinds to a halt as the new officials come up to speed. Policy decisions within the bureaus tend to flow up from the divisions. As a practical matter, they are the ones who first confront a new development. With front-line responsibility for specific areas, divisions are expected to develop solutions for matters under their control. Exceptions, however, do exist. Within the Ministry, the vice minister for international affairs often instigates reform in what amounts to a top-down process. MoF officials work hard, in part because of the macho climate and in part because of the relatively small number of career officials. The late nights, how­ ever, have explanations other than work load. For one thing, the culture within the MoF dictates superhuman hours, whether or not truly required. For another, personal contact often represents a large portion of the daily process, requiring an extended day to get things done. . THE QUALITIES THAT ENDURE The overview of the MoF allows for some generalizations. A sizeable portion of the Ministry’s current troubles have their roots in bureaucratic behavior. The two most critical problems concern the short terms that result from the rotation system and, with some exceptions, the failure to reward individual initiative. As a corollary, the bureaucracy tends to be intolerant of dissent, with the conse­ quence that the bureaus adhere to regulatory approaches long after they have become outmoded. Rapid Rotation. The MoF is hierarchical and stratified. Promotions are by class. Both seniority and title have importance. Conscious of hierarchy, junior members of the Ministry complain about a lack of direct contact with highranking officials. The emphasis on promotion by class has consequences. Each class wants to have an opportunity to hold all of the positions deemed stepping stones to the highest levels within the MoF. A class that does not get to head the Documen-

28

Bureaucratic Practices

tation or Personnel sections of the Secretariat will almost certainly not produce a vice minister. As a result, positions are held for only one or perhaps two years before the officials from a more junior class take over. Short terms mean that when an official has mastered a job, he or she rotates out. Deputy budget examiners (shusa) might start in the position with no ex­ perience and leave before they become truly effective. They have responsibility for a particular ministry’s budget for two years, hardly enough time to master the complexities and intricacies of that bureaucracy’s expenditures. The result is that a bottom-up analysis of the particular ministry’s budget never occurs. The rapid rotation system interferes with the development of expertise. Un­ derstanding the commercial lending process or derivative products can take years. Officials at the Ministry leave university with no experience in these matters. They learn through on-the-job training. Because career officials stay in a particular position only a few years before rotating to another post, often in a different bureau and involving an entirely different set of responsibilities, neither they nor the institution develop the requisite expertise. The problem of inadequate expertise is not Ministry-wide but related primarily to the financial bureaus. The MoF allows career officials to develop expertise in budgetary matters and tax issues. That has not been true in the financial markets. With occasional exceptions, few “ securities” and “ banking” experts (those understanding all facets of the industry) exist within the MoF. The lack of sophisticated experience affects policy decisions. When exposed to something new or complex, bureaucrats often opt for caution or even oppo­ sition. An MoF official once exclaimed, to no one in particular, that he would not approve any financial product he did not understand. It amounted to a poor approach to regulation, but one understandable given the prevailing bureaucratic pressures. The need for expertise versus a more generalized education represents a firm tension within the MoF. The MoF is perfectly capable of educating specialists. On the other hand, those with a more generalized education receive exposure to most of the broad functions under the auspices of the MoF and have an opportunity to build alliances, something critical to advancement. Moreover, every class wants to hold each important position. Leaving a career official in a critical post for more than two years can prevent this from happening. Risk Aversion. The promotion process also contributes to a significant aver­ sion to risk within the MoF. As career officials advance, the number of senior positions decreases. Once every member has attained the position of kacho or division director, the MoF will no longer have sufficient promotions for every­ one in a particular class. Avoiding risk represents a significant strategy of bureaucratic survival. To the extent that a scandal or mishap occurs under their watch, officials typically find their career advancement has come to an end. Indeed, those designated as can­ didates for the top positions within the MoF usually receive administratively

Inside the Ministry of Finance

29

important but low-risk positions, a strategy designed to avoid career-ending scandals. The practice of terminating a career over a scandal or mishap is so pervasive that the exceptions are well known. When politicians reversed the MoF’s efforts to institute the green card, a system designed to reduce tax evasion on interest from deposits, the person responsible—Makoto Utsumi— saw his career grind to a halt, causing him to consider resigning from the MoF. Resurrection oc­ curred, but only because of unusual intervention within the MoF and his prom­ inent role in tense negotiations with the U.S. during the Yen-Dollar talks. Matters are made worse by the bureaucratic system for apportioning blame. The bureaucracy does not have a practice of seeking the person who actually caused or overlooked the problems that ultimately culminated in a particular crisis. Instead, responsibility traditionally rests with the person in office at the time the matter surfaces. This is true even if the career official arrives the day before the scandal occurs. Takeshi Komura resigned as administrative vice minister in January 1998 to take responsibility for a scandal that involved improper behavior by bank ex­ aminers. The offending behavior occurred before he became vice minister and was nothing he controlled or supervised. Nonetheless, as the bureaucrat over­ seeing the entire ministry, he had to take responsibility, becoming the shortestreigning vice minister since the 1940s.14 Once officials rotate to a new position, therefore, they are absolved of any responsibility in connection with the prior post, even if their actions (or inac­ tions) exacerbated matters. The practice encourages officials to avoid dealing with difficult issues in the hope that they will rotate out before any problem occurs. The result is an endemic quality within the bureaucracy of avoiding responsibilities. In the area of financial inspections, career officials overseeing the process had no prior experience before assuming the position nor did headquarters in Tokyo provide detailed guidance on how to handle problems uncovered during exam­ inations. They tended to rely on the non-career staff for most of the expertise and to hope that no crisis developed before rotation to the next post. As a result, problems in the financial system were not addressed at early stages. Only when they had risen to the crisis level were steps taken. This might have been an acceptable approach when banks failed only rarely but was disastrous when problems began to occur simultaneously throughout the financial system. Short tenures and constant rotation contributed to the prevailing attitude of risk-avoidance within the MoF. Irrespective of the merits of a particular matter, Ministry officials had good reason to eschew the unknown. Given the lack of expertise, officials often lacked the depth of knowledge and experience to handle significant problems with confidence. Since an official would rotate out in a short time, a rational strategy was to delay any action in the hope that a crisis would not surface until a successor had taken over. The attitude manifested itself constantly. Efforts to obtain approval for a new

30

Bureaucratic Practices

securities product or a foreign branch license often confronted incessant delay. Talks would continue interminably, with officials looking ahead to their next position. Once officials rotated out of their posts, negotiations had to start over with the new, recently appointed officials. That meant additional delay. The bureaucratic system also rarely provided adequate reward for risk-taking. The career official who uncovered a difficult situation or wanted to take swift action over a new matter received little encouragement and, more importantly, little credit. Higher-ranking officials had the same institutional disincentive to assume the risks associated with a more forthright approach. In response to more risky behavior, therefore, lower ranking officials within the MoF often con­ fronted something approaching outright opposition or hostility from their su­ pervisors. Moreover, any decision affecting the status quo could also be accompanied by complaints from market participants opposing the effort. Affected financial institutions could raise the matter with the career official’s superiors. That would send a message that the responsible bureaucrat had been unable to manage matters. In these circumstances, bureaucrats, rather than be wrong or alienate constituencies, often preferred inaction or delay or, at best, modest change. Bureaucrats, therefore, eschew the novel or the controversial out of rational concern that something may go wrong and end their careers. The result is a bureaucracy that hesitates over change. In an era where the primary function was to tend to the compartmentalized financial system, the characteristic may not have been particularly damaging. Matters changed only incrementally. Se­ vere problems arose only occasionally. Today, in a far more complex environ­ ment, however, the approach has caused disastrous results. Leadership Problems. In each class, no more than one person can become administrative vice minister. Moreover, not all classes will attain the rank. Fierce competition exists within each class, therefore, to produce a candidate that will gain the top position. While those attaining the highest rank may not be clearly identified until they have reached their mid-40s, the process of designating leading candidates from each class begins the day that career officials enter the MoF. Although those within a class are promoted in lockstep, certain positions are more important than others. Even the first positions in the MoF provide indications of an offi­ cial’s future. Those going to the Budget Bureau or the Secretariat are already on the fast track. The system of early designation has consequences. Those knowing that they may make it to the top of the MoF prefer positions that are less likely to result in a career-ending controversy or blunder. The tendency, therefore, is to give those officials sensitive but not particularly controversial positions. Moreover, already on the fast track, they do not need to distinguish themselves through decisive behavior or problem-solving. Instead, they will usually be judged by how well they are_ able to minimize controversy and problems in a particular post. As a result, the training of future administrative vice ministers and directors

Inside the Ministry of Finance

31

general of the various bureaus involves less an exercise in leadership than in consensus-building and conflict-avoidance. Eisuke Sakakibara, who became international vice minister in 1997, took a number of bureaucratic risks and at least one, his commemorative coin scheme, was generally deemed a failure. He took the risks because his record for pro­ motion was so weak that he had nothing to lose. While his promotion to zaimukan would seem to be evidence that those taking a more decisive role could obtain the top ranks of the bureaucracy, it was not the case. In general, he engendered strong opposition within the MoF and obtained his promotion pri­ marily as a result of political intervention. The training, therefore, often does not prepare these officials for the task of running the MoF, particularly in a more complex era. Moreover, the early des­ ignation of front runners in a class ultimately sends a signal to all others that they have no ability to reach the top ranks of the MoF. Early designation also conspires against decisiveness, with those officials on the upward trajectory wanting to avoid controversies that would impede their advancement and that would affect the quality of their retirement position.

CHAPTER 3

The M inistry of Finance an d th e P riv ate S ecto r

The Ministry of Finance performs a number of tasks throughout the financial system. In particular, the Ministry monitors activity in the market, helps shape the consensus over regulatory reform, and enforces the reigning legal regime. The MoF has a handful of tools that facilitate the task. The two most critical are gyosei shido (administrative guidance) and amakudari (descent from heaven). Both have recently come under protracted criticism and are generally misunderstood. Administrative guidance has traditionally been viewed as an informal means of articulating mandatory requirements. Guidance amounted to the principal method used by the MoF to micromanage the financial markets. Every signifi­ cant step taken by banks and securities firms required informal MoF review and acquiescence. In fact, however, this represents too narrow a view. The concept of admin­ istrative guidance is much richer and has a number of purposes and causes. The practice involves a constant exchange of information between bureaucrats and their wards. Industry officials and bureaucrats communicate daily, often on mul­ tiple occasions. With the hallmark of “ no surprises,” financial institutions report all developments of any significance to Ministry officials, typically at formative stages. It is the importance of the development rather than a legal obligation that dictates disclosure to Ministry officials. The relentless disclosure by private firms provides the MoF with an oppor­ tunity to comment on developments while they are still in the planning stage. Bureaucrats can use the opportunity to impede, influence, or even prevent, a particular practice. They can develop a solution or prepare a response prior to public awareness, contributing to the appearance of control. It also allows them to delay matters either to avoid controversy or to give industry time to prepare.

The Ministry of Finance and the Private Sector

33

To the extent bureaucrats express hesitancy or even opposition when infor­ mally told about a development, the financial institution will not go forward. It makes no difference whether the MoF has express legal authority to stop the transaction. Given the close relationship between regulator and regulated, banks, securities firms and insurance companies simply do not take steps after receiving the MoF’s disapprobation. The information flow, however, goes both ways. The MoF uses the constant contact to obtain opinions on, and to assess the efficacy of, new regulations or policy changes. Officials in the Banking and Securities bureaus in particular need the communication flow since they have no private-sector experience in the industries they regulate. At the same time, industry receives a preview of any regulatory initiative and advance knowledge of impending examinations. Guidance, therefore, occurs as a natural consequence of the constant contact between regulators and regulated. In other words, the practice is an inherent part of the relationship between bureaucrats and the entities they regulate. Similarly the practice of amakudari also impacts relations between bureau­ crats and financial institutions. Following retirement, rafts of retired Ministry and central bank officials disperse throughout the financial system. They go to a variety of entities, including government-affiliated financial institutions and public corporations. Others accept positions in the private sector and self-reg­ ulatory organizations, including president of the Tokyo Stock Exchange. Amakudari occurs for a number of reasons. Foremost, it is a sinecure for longstanding government service. With few responsibilities, officials often use these posts to wind down their careers at an attractive salary and for abundant time on the golf course. In this sense, amakudari largely amounts to a privatesector subsidy for retired Ministry officials. The practice, however, also has more substantive purposes. It enhances the MoF’s ability to oversee the financial markets. Placing retired officials through­ out the private sector provides a fifth column that can facilitate the implemen­ tation of government policies. The network can act as a catalyst for change, something critical in financial markets riveted by vested interests opposed to alterations in the status quo. The network of retired officials has yet another more subtle purpose. It rep­ resents a source of private-sector information for a bureaucracy that otherwise has no private-sector experience. A sort of informal enforcement network, it also guarantees that financial institutions will abide by the reigning regulatory scheme. Deviations unknown to the MoF might surface through the network of retired officials, generating the necessary bureaucratic response.

AMAKUDARI Upon retirement, officials from the Ministry typically begin second careers. The practice, known as amakudari or “ descent from heaven,” reflects the pre­ vailing attitude about the exalted role of the bureaucracy. Retiring officials de-

Bureaucratic Practices

34

scend from their government positions to a more base realm of the private sector or public corporations. Despite their new positions, loyalty remains with the MoF. As with other ministries, the MoF fosters continued attachment among retired bureaucrats. It does so through a network of groups and associations that maintain ties. An entering class will meet, typically on a monthly basis, even after retirement. In addition, however, the Society of the Friends of the MoF (Okura Doyu Kai), an association of retired MoF officials who attained the rank of kacho or above, convenes quarterly. Finally, more select groups meet. The Karuta Kai is a small group (40 or 50) of the most powerful alums that meets in the first week of January over dinner. Although having long since retired from the MoF, notable alumni such as Kiichi Miyazawa regularly attend the elevated affair. The Practice Amakudari is partially driven by economic necessity. Only a handful of of­ ficials are promoted to the highest posts in each ministry. The others receive the “ tap on the shoulder,” a euphemism for mandatory retirement. In their mid50s, the first group of retirees has a good 10 years of service remaining. Officials essentially receive attractive sinecures as a reward for long-standing public serv­ ice. Amakudari, however, has a number of other justifications beyond economic need. The practice strengthens ties between regulator and regulated. By accept­ ing the retired officials, banks not only obtain high-quality personnel but also receive insight into government thinking on a variety of issues. In particular, smaller banks without significant clout need the retired officials to gain access to decision makers in the MoF. Among Japanese bureaucracies, the MoF has consistently proved the most successful at obtaining positions for retiring officials. In 1993, 208 career bu­ reaucrats “ descended from heaven,” with the largest number, 64, from the MoF. The Construction Ministry finished second with 22. The numbers reflect both the caliber of the retiring officials and the continuing need for influence with the MoF. Within the MoF, the mundane task of arranging the positions falls upon the Secretariat. The Secretariat not only must maintain an adequate supply of po­ sitions but also must find posts commensurate with the retiring official’s rank and stature. Moreover, the task is relentless. Retired officials may serve in a position for only a few years and will expect the Ministry to arrange a successor landing pad. The Positions The descent may be to any one of a variety of sectors, including governmentaffiliated financial institutions, public corporations, private companies (particu-

The Ministry of Finance and the Private Sector

35

larly financial institutions) and trade associations. The positions each have a prestige rating that must equal the official’s last rank held within the MoF. Some posts are shiteiseki (reserved seats), designed primarily for retired vice ministers. They include every other governor of the Bank of Japan, and the heads of the Export-Import Bank, the Japan Development Bank, the Overseas Economic Co­ operation Fund, and the People’s Finance Corporation. In the private sector, retired officials have routinely been placed in regional and trust banks. The Bank of Yokohama, the largest regional bank, regularly takes such officials, with its last three presidents coming from the MoF. Long­ term credit banks also regularly accept the retired officials, as do smaller, sec­ ond-tier banks. Not all financial institutions, however, take advantage of amakudari. In par­ ticular, the former zaibatsu banks have generally refused to do so.1 Proud, with long histories, these financial institutions are almost militant in resisting the descending officials. Accepting a single bureaucrat, it was feared, would create the expectation of future descents; better not to open the door. As zaibatsu banks merge with other financial institutions, the practice of not accepting MoF offi­ cials has continued and even strengthened. This could be seen in connection with the merger between Mitsubishi and the Bank of Tokyo (BoT). The BoT had particularly strong and obvious ties to the government. In some respects, the explanation was historical. The bank’s prewar predecessor, the Yokohama Specie Bank, had been a special bank subject to strong government influence. In the postwar era, government goodwill was nec­ essary for the BoT to maintain international preeminence among Japanese banks. The bank received deposits of the government’s dollar reserves and was allowed more rapid foreign expansion. The BoT, therefore, sought to solidify relations with regulators through the acceptance of descending officials. The BoT’s first president, Katsuhiko Hamaguchi, the son of a former prime minister, had worked for the Bank of Japan. With the hiring of Takashi Ihara from the MoF in 1954 as a managing director, the bank continuously had at least one Ministry official in a policy-making position until the merger. Sumio Hara, who served as the director general of the Tax Bureau and commissioner of the National Tax Administration Agency, joined the bank in 1962 and served as president or chairman from 1965 until 1977. In the 1970s, Yusuke Kashiwagi, the first modern zaimukan or vice minister of international affairs, joined the BoT. Kashiwagi had the added benefit of having had a father who served as president of the Yokohama Specie Bank. Although he had spent time in both the Budget Bureau and Secretariat, Kashi­ wagi’s bureaucratic career had a decidedly international flavor, no doubt in part because of his upbringing in the U.S. and his absolute command of English. He became president in 1977, when Sumio Hara retired, and chairman in 1982. In 1992, Kashiwagi was succeeded by another vice minister of international affairs, Toyoo Gyoten. In the securities sector, the descent from heaven has usually meant positions

Bureaucratic Practices

36

with trade associations and research institutes connected to the largest brokers. Retired officials have also landed in stock exchanges and other self-regulatory organizations, although rarely in the securities companies themselves.2 A 1991 survey showed that 31 Ministry officials held key positions in the securities industry. The positions accepted by retiring officials in the securities sector have in­ cluded: president and vice president of the Tokyo Stock Exchange (TSE) as well as the heads of other, smaller exchanges; chairman of the Japan Securities In­ vestment Advisors Association; president of the Tokyo International Financial Futures Exchange; vice chairman (but, significantly, not the chairman) of the Japan Securities Dealers Association (JSDA);3 and vice president of the Secu­ rities Investment Trust Association. They also include a number of think tanks. Retired officials routinely head the Nomura Research Institute, an affiliate of the country’s largest securities firm, as well as think tanks associated with the other large securities firms. They also serve as the president of the Capital Market Promotion Foundation and the Capital Market Research Institute. Occasionally, Ministry officials also affiliate themselves with foreign firms. For the first 30 years after the end of the occupation, descending to foreign firms was rare, at least for high ranking career officials. Given the modest stature of these firms, their low level of involvement in the Japanese economy, and the cultural differences with domestic firms, retired government officials generally avoided them. In more recent years, however, the practice has become more common. For­ eign firms have improved their standing and emerged as more popular landing pads. Takeshi Ohta, the deputy governor of the Bank of Japan, became a director of Kleinwort Benson. Hideo Suzuki served as honorary chairman of Goldman Sachs (Japan). Michiya Matsukawa, a former international vice minister, became the first Asian member of the advisory board for Morgan Stanley. As more foreign competitors enter the country and increasing numbers of Japanese offi­ cials search for positions, such relationships will likely become more frequent. The Limits Amakudari has lately come under sharp criticism. The primary challenge fo­ cuses on the seemingly excessive closeness between the MoF and the industries it regulates. To continue to induce financial institutions to accept retiring offi­ cials, some contend that MoF officials have an incentive to take a more lenient approach toward regulation or provide special access. In fact, this is a largely inaccurate description. From the perspective of financial institutions, accepting the retired officials has always been a mixed blessing. A career in the bureaucracy does not prove to be particularly apt training for a position in the private sector.4 Nor does the private sector obtain undivided loyalty. The loyalty of the retired officials typ­

The Ministry of Finance and the Private Sector

37

ically remains with the Ministry. Retired officials are in a position to report any deviation from conventional practices to their juniors in the MoF, arguably a mechanism for ensuring uniform behavior. Moreover, while hiring the officials could provide some additional access to the Ministry, the financial institutions with the most influence did not accept the retiring bureaucrats. In the postwar era, the former zaibatsu banks resolutely refused to engage in amakudari. Nonetheless, they continued to maintain con­ siderable influence with, and have access to, bureaucrats in the Banking Bureau. Those financial institutions that felt compelled to accept the retiring bureau­ crats also had a number of mechanisms for minimizing their influence. Amak­ udari positions often sounded impressive but in fact carried little power. Some were sent to research institutes or given the title of chairman, a prominent but largely ceremonial post. In that way, the positions amounted to a cost of doing business but entailed little interference in the actual management of the financial institution. From the bureaucratic perspective, the network of officials also represents a mixed blessing. To some degree, it was a reward for a long and demanding bureaucratic career. It also provided a mechanism for facilitating change. The impetus for reform sometimes originated with regulators (such as the introduc­ tion of reserve requirements) but more often arises from participants in the private sector. Whatever the merits of a proposed reform, it invariably engen­ dered heated opposition from industry, particularly those likely to be disadvan­ taged. Forming a new consensus in these circumstances was not easy. In the financial markets, the MoF could not negotiate with every participant. Instead, discussions occurred with entities that could speak on behalf of their respective industries or categories of financial institutions. In the securities area, the JSDA and the TSE constituted the principal representatives of the brokerage community. With large commercial banks, the task fell to the Federation of Bankers Association. The network of retired officials essentially provided the MoF with supporters within industry that could help influence the debate. The network could not dictate outcomes. It could give the views and goals of the Ministry and it ac­ centuated opportunity for discussion. As a consensus gradually emerged, these officials could play a role in pushing the process along. Amakudari, therefore, provided a network that could work toward the successful completion of MoFinspired initiatives in the financial markets. At the same time, however, amakudari generated problems. To a large extent, the network of retired officials represented another informal channel for gath­ ering intelligence about developments in the financial markets. Bureaucrats run­ ning a financial institution knew what it was doing and what problems it was having. The expectation was that any financial institution headed by a finance bureaucrat was safe and well run, if not stodgy. In fact, however, financial institutions proved adept at keeping bureaucrats from knowing their true state of affairs. The MoF lost considerable credibility

38

Bureaucratic Practices

in the 1990s when some of the biggest, most public failures in the financial markets occurred under the tutelage of a Ministry bureaucrat. Hyogo Bank, the first post-occupation bank to fail, was headed by a former bureaucrat from the MoF. The housing loan companies or jusen were riddled with retired govern­ ment officials. In many respects, therefore, the network of officials did not im­ prove the MoF’s intelligence but did lead to considerable embarrassment. In reaction to the current criticism of amakudari, the MoF has unofficially but deliberately reduced the number of retired bureaucrats placed in substantive positions in private financial institutions.5 From the bureaucratic perspective, the policy will likely be temporary, kept in place as long as politicians and the public continue to oppose amakudari. There is reason to believe, however, that a more permanent change in the practice will occur, with the impetus coming from industry. The number of important, substantive positions have gone into permanent decline. Smaller private financial institutions will continue to accept the officials, thereby obtaining greater access to bureaucrats in the MoF. The more powerful banks and securities firms, however, have been doing so in declining numbers. The Mitsubishi-Bank of Tokyo merger eliminated an important post for retiring bureaucrats; so did the combination between Mitsui and Taiyo-Kobe Banks, forming Sakura. Even those institutions that will continue to accept the officials will increas­ ingly put them into important-sounding but largely powerless positions. The largest Japanese securities companies did not accept bureaucrats for their man­ agement teams but did make them heads of their research institutes. In these posts, bureaucrats had little ability to influence day-to-day operations. While amakudari will remain a fixture in the financial markets, its importance for bureaucrats will change. The Ministry will still find positions for retiring bureaucrats with lucrative salaries and impressive titles. With the largest banks and securities firms increasingly declining to accept the retiring officials in sub­ stantive positions, however, the MoF’s reliance on the practice to gather intel­ ligence and implement reform will decline.

ADMINISTRATIVE GUIDANCE Administrative guidance has been viewed as the critical bureaucratic weapon used to control the financial markets. Banks and securities companies would preclear all important matters with the MoF. The Ministry bureaucrats could comment on, and influence the outcome of, any development before it occurred. Largely a postwar phenomenon, the interventionist approach of the Ministry did not always exist. Before the conflict, countervailing authority of the zaibatsu banks limited the MoF’s authority. Large and connected to industrial groups, the zaibatsu banks had little need for Ministry approvals. So influential were these financial institutions that the Finance Minister, until the 1930s, often came

The Ministry of Finance and the Private Sector

39

from a zaibatsu bank. Oversight by the MoF was therefore lax. For the 17-year period after 1927, the MoF inspected zaibatsu banks only once, all in 1935.6 By the end of the war, however, the zaibatsu banks were too weak to resist the authority of the MoF. Moreover, other financial regulators had been van­ quished or weakened. The Bank of Japan remained under MoF oversight as a result of wartime legislation. The Securities and Exchange Commission disap­ peared, reduced to a subdivision within the Treasury Bureau. The Fair Trade Commission was marginalized, with the chairman typically a retired vice min­ ister from the MoF. Given the MoF’s unequaled stature and central role in the financial markets, industry had no choice but to try to maintain positive relations. As a result, a pattern of behavior emerged. Contact between MoF officials and financial in­ stitutions was constant, even daily. Bureaucrats had to be told about any devel­ opment of significance before it occurred. The practice of preclearance gave bureaucrats the ability to influence activities at formative stages. The Ministry also used the practice of constant communication to institute uniform, industry-wide standards. Standardized practices could be imposed by the MoF or through the rules of industry associations, such as the Zenginkyo, or self-regulatory organizations, such as the Tokyo Stock Exchange. Rule changes by these organizations, however, had to be precleared through the rel­ evant bureau within the MoF. Bureaucrats unhappy with a particular practice rarely had to say no. Instead, officials in the applicable bureau let it be known that the time was not right for that particular action. Banks or securities firms dared not go ahead in the face of such bureaucratic disapprobation. Conversely, informal approval was tanta­ mount to acceptance. Submission of a formal application amounted to a rote formality, a final ritual. The most potent manifestation of Ministry authority, therefore, was rarely seen. This came from the ability to alter or eradicate practices before they be­ came public. The influence was ubiquitous. Financial institutions simply did not take steps of any significance without giving the MoF an opportunity to shape and alter them. Moreover, with edicts rarely reduced to writing, government officials could ultimately avoid blame by disavowing responsibility when things went wrong. The MoF learned about the practices of private sector participants; banks and securities firms learned what regulatory initiatives the MoF had under consid­ eration. Legal parameters mattered less than maintaining regulatory good will and a constant, two-way flow of information. The System Administrative guidance involved “ advice” on the appropriate course of ac­ tivity to be taken by a financial institution. The advice could be distributed on the phone, at social occasions, or in face-to-face meetings at the Ministry. In-

40

Bureaucratic Practices

formation could also be transmitted through industry associations or selfregulatory organizations. Personal communication represented the preferred method of disclosing important developments. In effect, it supplanted official reports and inspections as the main mechanism for obtaining information in the financial markets. Administrative guidance, like amakudari, was often characterized as another device associated with Ministry control of the financial markets. The MoF, through informal communications, tightly regulated private sector practices. Moreover, without access to these sotto voce interpretations, other (particularly foreign) financial institutions found themselves disadvantaged. This view, however, confused the procedure with the practice. Nothing in­ herently wrong resulted from the dispensation of regulatory views through a more informal mode. Nor, frankly, were the MoF’s positions particularly hard to discern, at least for those with the skills and inclination to learn them. In fact, one of the most significant problems confronted by those communicating with the MoF was the very real possibility that the matter would leak to others in the financial system. Administrative guidance arose directly out of the bureaucratic structure em­ ployed in Japan in general and the MoF in particular. Although of the highest caliber, government officials were practically unprepared for their regulatory task. As university graduates, they had no actual hands-on experience in the industries they regulated. With no private-sector experience, bureaucrats in the MoF constantly collected information about practices in the financial sector. Moreover, internal training did not compensate for the lack of practical ex­ pertise. In connection with the financial markets, the MoF educated generalists. Annual rotations in and out of various bureaus meant that officials usually did not gain significant expertise in one area. The MoF, therefore, needed the daily contacts with brokers and banks to learn what was going on in the market and to obtain feedback on the impact of various regulatory approaches. Bureaucrats benefited from the flow of information in other ways. By learning about impending developments, the MoF could prepare a response or solution prior to public dissemination. The practice, therefore, contributed to the im­ pression that the MoF knew about events in the financial markets before they occurred and was a guiding force behind any change. Surprising the MoF would lessen its reputation for complete control. Advanced awareness also coincided with the risk-averse tendencies of the bureaucracy. In deciding bureaucratic promotions, little credit went to career officials who sought out and confronted controversial matters. Controversies could result in a failure or embarrassing debacle, something that would blemish an official’s record and damage career advancement. Advance notice allowed bureaucrats to control the timing of a new or risky matter. Decisions could be delayed until just before or just after they had rotated to a new position. Those

The Ministry of Finance and the Private Sector

41

seeking approval would often be told that the time was not right, bureaucratese for “ wait until the next set of rotations.” Administrative guidance had one other important use. With edicts often not reduced to writing and answers rarely direct, bureaucrats could ultimately avoid blame by disavowing responsibility when things went wrong. Bureaucrats were not the only ones to gain from the system of preclearance; industry also benefited. In the postwar system, it represented a mechanism for ensuring that no competitor obtained a disproportionate advantage. Through pre­ clearance, officials from the Banking or Securities Bureau learned about any novel practice before it was introduced. Bureaucrats would then “ test” the prac­ tice by disclosing it to other financial institutions for comment. As a result, the innovation would become common knowledge throughout the financial industry. While the innovator might still engage in the practice first, other financial institutions learned about it and had time to copy the practice. The competitive advantage, therefore, was modest and lasted an exceedingly short time. In short, preclearance averted any kind of destabilizing advantage. Banks and securities companies, therefore, accepted bureaucratic intrusion because they benefited. While it limited their ability to innovate, they knew that their competitors were subject to the same restraints. In a carefully compart­ mentalized financial system, no competitor would be allowed to develop a de­ stabilizing advantage. As a result, however, uniformity reigned. Banks had common operating hours. Charges for withdrawals and use of ATM machines were uniform. Limits existed on advertising. The Banking Bureau’s decision to define ATM machines as branches effectively meant that they were open only during banking hours, pre­ cluding 24-hour service. Administrative Guidance and Bureaucratic Leverage Administrative guidance was, therefore, an inherent part of the postwar sys­ tem. Adherence was not, however, entirely voluntary. The MoF also had a num­ ber of mechanisms that provided leverage and ensured compliance. Banks obtained a significant portion of their funds for lending from the central bank, something that could be cut off or reduced for those acting in an un­ cooperative fashion. They could become subject to increased attention from tax inspectors or bank examiners, all tasks handled by the MoF or the Bank of Japan. Applications for additional authority in the financial markets could sud­ denly confront delay. Moreover, whole categories of financial institutions could be threatened. In the postwar compartmentalized financial system, trust banks, for example, knew that the policies of the MoF rather than any law kept commercial banks and securities companies out of their bailiwick. The implicit threat always existed that an unhappy MoF might change the policy. The most feared form of regulatory retribution, however, concerned the right

Bureaucratic Practices

42

to open, close or move bank branches. Particularly after the war, banks desper­ ately needed to reconfigure their branch networks to reflect changed circum­ stances and population shifts. Moreover, in the compartmentalized banking system, the number of branches had an accentuated importance, both for the stature and profitability of commercial banks. City banks were unable to issue bonds, constraining their ability to raise funds. This left deposits as the most important source of funding. With interest rate controls making price competition impossible, the only way to increase deposits was through additional branches. Additional deposits meant additional lending. Increased lending meant increased profitability. The additional business also had important psychological ramifications. In general, banks in Japan were ranked by total assets (primarily loans). As a result, additional branches not only meant more business but also potential shifts in ranking. Ranking carried prestige and influence. The Banking Bureau gave greater access and preferential treatment to the largest banks. Banks, therefore, closely watched the growth in the branch networks of their competitors and looked for any opportunity to increase theirs. The Ministry had essentially unlimited discretion to approve (or not approve) any change in the branch network. With a relentless need to open or move offices, banks had to maintain good relations with the Ministry. An aroused MoF could show displeasure simply by allowing branch applications to languish, effectively depriving the uncooperative bank of much desired funding. Communications Ministry oversight represented an intensely personal affair. Approval for a particular transaction required one-on-one negotiations with the relevant official in the relevant bureau. Administrative guidance and informal relations worked because of the small number of important participants and the implicit agreement that no one would obtain a destabilizing competitive advantage. To facilitate contact, banks, securities firms and insurance companies all had an “ MoFTan” (a combination of MoF and tanto, meaning “ in charge of” ), an official responsible for relations with the Ministry. To deal with the mandarins at the Ministry, the MoFTan needed the appropriate background, typically a degree from the University of Tokyo. The contacts involved elaborate after-work socializing and relationship build­ ing. The slow process of developing contacts meant that MoFTans often re­ mained in their positions for extended periods of time, an exception to the usual system of rapid rotation. The importance of the position could be seen from the promotions given to the MoFTan. They were sometimes stepping stones to the top positions in financial institutions. These officials or their subordinates traveled to the Ministry daily, even twice daily, to provide information and discuss developments. To the extent that the MoF wanted the industry to be aware of a new policy, officials could simply

The Ministry of Finance and the Private Sector

43

tell the MoFTans when they arrived or called. Similarly, with the right contacts, the MoFTan could learn about scheduled examinations or other affirmative steps by the MoF. Daily contact had no inherently nefarious or conspiratorial purpose. The MoF used the contacts to obtain information. Bureaucrats also effectively shifted some of the work load of the Ministry back to the private sector. A Ministry official might ask for data or statistics about practices in the market with the expectation that the information would be provided, often later the same day. This saved the MoF the difficulty of developing the information directly. The position, however, was far more than a conduit for information. Given their lack of expertise, MoF officials in the financial bureaus relied on MoFTans to develop policies or solutions to problems in the financial markets. Often having rotated into their posts with no prior experience, bureaucrats would in­ teract with MoFTans who had often been in office for long periods and rely on their expertise. The pattern was for MoF officials to ask for the ‘‘private’’ views of a partic­ ular MoFTan, fully expecting to get a response that reflected a consensus among all of the important industry participants. In that way, bureaucrats could adopt these “ private” views as their own and also know that they already had industry support. A written document provided by the MoFTan explaining the views could be altered slightly and issued by the relevant bureaucrats. Information given to the MoF by any financial institution amounted to a form of industry-wide disclosure. Banks and securities companies disclosing matters to the MoF knew that their actions would eventually be transmitted to the entire market. International matters, for example, quickly became known to the Bank of Tokyo. To prevent other banks from becoming aware of the activity, the MoF was sometimes informed only in the final stages. When consortium banks were cre­ ated in the late 1960s, some Japanese banks knew that the Bank of Tokyo, the country’s premiere international bank, would be told about the membership of each consortium once the MoF had been informed. They therefore delayed dis­ closure to regulators. Given the need for secrecy, contacts with the Ministry often involved a certain degree of stealth. With competitors always at the Ministry, they could observe meetings. Simply knowing that a meeting took place with high-ranking officials in the Securities or Banking Bureaus could give away the purpose. Bank offi­ cials, therefore, would remove lapel pins or indicia of employment when in­ volved in sensitive meetings. The communication process also entailed a discemable set of rituals. To the extent a bank or securities company actually sought bureau approval or assent to a particular activity, principles of hierarchy had to be strictly observed. Only officials on comparable levels could meet to discuss matters. Moreover, the process usually began at the bottom. A lower-level bank employee would dis-

Bureaucratic Practices

44

cuss the issue with the relevant junior officer at the Ministry, usually a deputy director or kacho hosa. The idea of going right to the top amounted to a non-starter. The pinnacle— the Minister of Finance— typically relied on recommendations from the bureauc­ racy. More importantly, bypassing lower levels could result in the official’s loss of face. Junior officials ultimately became senior officials, and they had long memories. Earning their enmity was to be avoided. A few days after contacting the assistant director, higher officials of the bank or securities firm would visit with the director of the relevant division (kacho). The delay would give the kacho hosa time to brief superiors and develop a bureaucratic response. The contacts could end with the kacho or, depending upon the importance of the matter, continue to the relevant deputy director general, the number two person in the bureau. Finally, for extremely sensitive matters, a meeting might be necessary with the director general of the Banking or Securities Bureau, effectively the final word. To meet with a director general required at least the presence of a president or managing director from the bank or broker. In instances where the protocol was not observed, results often failed to meet expectations. When Nomura wanted to start a trust company with Morgan Guar­ anty, it scheduled a meeting with the Finance Minister, Noboru Takeshita. The failure first to negotiate with the relevant personnel in the Securities Bureau engendered bureaucratic opposition, with the proposal going nowhere. The Limits To some, the system of preclearance amounted to an inherent component of Japan’s regulatory philosophy. Businesses could not exploit gaps or vague lan­ guage in the law but had to seek bureaucratic approval for anything not expressly authorized. In fact, guidance had little to do with the perceived legality of the matter. Instead, the practice arose out of the nature of the relationship between in­ dustry and regulator, not from the philosophy with respect to exploiting statutory gaps. The practice was accepted because of a consensus over the role of the financial system in the economic recovery of Japan. Moreover, banks and se­ curities companies benefited directly through limits on competition and guar­ anteed profit margins. In other words, financial institutions prospered under the system of tight control. Administrative guidance also represented a useful, legitimate mechanism for disseminating agency views and enforcing regulatory requirements. The practice had the benefit of flexibility. Regulators could, within the broad parameters of legislation, alter positions as circumstances dictated. Thus, as the economy shifted or a consensus changed, they did not need to go through some formal process or request additional legislation from the Diet. Nor was guidance used to impose unwanted policies on industry. The system

The Ministry of Finance and the Private Sector

45

contained implicit norms that limited the Ministry’s discretion. Equal treatment was critical; banks were concerned with their relative ranking, something that could change if bureaucrats varied the number of branches or the amount each bank could lend. New policies were applied not in an arbitrary fashion, but only after careful development of a consensus on the appropriate direction. To the extent strong disagreement existed over policy shifts within the affected industry, the Ministry had little ability to force through the changes. Attempts to do so would have damaged credibility and the likelihood of compliance, and all but invited polit­ ical intervention, a bureaucratic anathema. The relevant bureau within the MoF, therefore, remained, to some degree, a captive of industry. Indeed, non-compliance was a fixture in the system. Banks occasionally tried to avoid ceilings on lending imposed by window guidance through “ off-record” loans. They also sometimes increased loans beyond the limits “ suggested” by the regulators. When the MoF sought to reduce real estate lending in the early 1990s, commercial banks sent clients to other financial institutions not subject to the guidance, effectively circumventing the requirement. The concerns associated with guidance did not, therefore, arise out of secret interpretations selectively disclosed or the arbitrary exercise of authority. The real difficulty occurred where the Ministry had not yet formulated a consistent position on an issue. In those circumstances, bureaucrats viewed any change with suspicion. To avoid damaging a career, the relevant MoF official wanted to know that the development would not harm the financial system or result in embarrassment. Slow decision making within the MoF also coincided with the system of constant rotation of career officials. A bureaucrat recently inserted into a new substantive position could be counted on to delay decisions on anything signif­ icant until he or she had enough on-the-job training. At the other end, a bu­ reaucrat about to rotate to another position had an incentive to delay and leave the matter for a successor. To the extent new policies were developed, bureaucrats relied extensively on MoFTans at the largest financial institutions to provide ideas and forge the necessary consensus. MoFTans provided the very expertise they lacked. Doing so ensured that industry would not object, thereby reducing controversy. At the same time, however, other groups such as consumers were not consulted. The result was a stream of policy decisions generally unfavorable to consumers. Many of the problems associated with administrative guidance will decline as financial institutions increasingly decide not to preclear developments with bureaucrats. That has already begun to occur. In addition, bureaucratic changes that result in greater substantive expertise will reduce dependency upon the daily contacts with industry and increase bureaucratic willingness to be more decisive. Finally, the nature of the MoFTan position will evolve. In the postwar system, the best and the brightest were placed in the position, reflecting the belief that harmonious relations with the MoF was the most important task within the

46

Bureaucratic Practices

financial institution. In an era of greater competition and less protection, rela­ tions with the MoF will fall in importance. The best and the brightest will be redirected to more critical positions, with the MoFTan post declining in power and quality. Promises by banks to eliminate the position following recent scandals in­ volving excessive entertainment of bureaucrats, however, represent more form than substance. For the foreseeable future, private financial institutions still need to maintain positive relations with bureaucrats and discuss regulatory initiatives. Moreover, in the absence of private-sector experience and expertise, bureaucrats in the MoF continue to need the contacts. Thus, while a specialized office of MoFTan may in some cases be eliminated and entertainment will certainly de­ cline, the contacts will continue.

PART II

Management of the Financial Markets

CHAPTER 4

The P o stw a r Financial S ystem

The Ministry of Finance’s domestic power comes primarily from its control over the budget process. Its international renown, however, derives from supervision of the financial markets. These markets played an important, if not decisive, role in the country’s economic recovery. Banks had a central role in the process. They amounted to the principal ve­ hicle for financing growth, with small banks funneling deposits to larger ones which in turn lent them to companies deemed important to the country’s recov­ ery. With an implicit government guarantee of the loans, banks did not need to maintain the usual protections designed to minimize the impact of financial reverses. For much of the postwar period, they had a small capital base, minimal reserves, and little need to develop a capacity for risk assessment. The laboring oar for oversight fell to the Banking Bureau. Created in 1927, the bureau in the postwar financial system was responsible for managing the flow of funds to corporate Japan. Doing so required a stable financial system, including an adequate supply of foreign reserves. The Banking Bureau as part of its oversight deliberately avoided anything that might have significantly de­ stabilized the system, including reckless competition that could impair weaker banks. The Japanese financial system through most of the postwar era represented the epitome of stability. No bank failed; indeed, a deposit insurance system did not even exist until the 1970s and was not required to make a payment as part of a bailout until the 1990s. Banks did become insolvent. Heiwa Sogo in the 1980s failed. The Banking Bureau handled the problem quietly and discretely, with Sumitomo absorbing the ailing bank in part to acquire its network of Tokyo branches. The system produced some troubling side effects. Banks engaged in policies

50

Management of the Financial Markets

that were largely anti-consumer in practice if not intent. Loans met the credit needs of corporate Japan but not Mrs. Watanabe. Interest rates on bank deposits were kept low, with individuals essentially subsidizing the cost of funds for companies. Nonetheless, it was hard to argue with the results. Japan became the first country in the postwar period to undergo sustained double digit growth. In only one generation, the country went from war-tom and poor to industrialized and rich. THE SHAPE OF THE FINANCIAL SYSTEM The system worked because of the unique conditions that existed in postwar Japan. Foremost was the severe capital shortage. With funds in tight supply, the financial system became the mechanism for accumulating and disbursing capital to those companies that could best contribute to the economic recovery. The system functioned for a number of reasons. Foremost, it was closed. Depositors had no place to put funds other than in banks. Banks, in turn, rep­ resented the only consistent source of capital for corporate Japan. The MoF tightly limited those companies that could make equity offerings to the public, with newer companies almost completely foreclosed. Public bond markets did not exist in any meaningful sense. Companies had nowhere to go for their capital needs except banks. Second, banks received a guaranteed source of low-cost funds, allowing them to lend at reasonable rates and still make a healthy profit. The largest banks received most funds used for lending from deposits. To supplement that supply, the Bank of Japan made available additional funds at its discount window. In­ terest rates were kept intentionally low, reducing the cost of funds for financial institutions, savings that could be passed along to corporate Japan. Third, competition was limited. Financial institutions were divided into com­ partments, with each having a monopoly on a particular area of business. Trust banks were responsible for asset management, city banks for short term loans to corporate Japan. Long-term credit banks had responsibility for loans of longer duration, the Bank of Tokyo for overseas activities, and securities companies for underwriting corporate debt and equity. Competition within each segment was also limited. After the licensing of the Nippon Credit Bank in 1957 and Chuo Trust in 1962, the Banking Bureau essentially did not permit another new Japanese bank to enter the market until forced by economic circumstances in the 1990s. In fact, the regulatory emphasis was on consolidation and reduction in the number of financial institutions. The result was exceptional stability within the financial system and within each particular compartment. The number of long-term credit banks remained permanently fixed at three. After the forced separation of trust departments from commercial banks (Daiwa excepted), the number of trust banks remained at seven. The quantity of city banks did fluctuate, not because of the entry of new financial institutions, but because of mergers or changes in status from regional

The Postwar Financial System

51

to city bank. Moreover, within each category, the relative rankings of the banks rarely underwent significant change. The limitations on excessive competition may have been the single most im­ portant reason for the success of the system. Financial institutions knew that an existing bank or securities company would not be allowed a decisive business advantage that could disrupt the carefully manicured system, that the source of funding for loans would not favor any particular financial institution, and that no new competitors would be allowed into their compartment. In return, finan­ cial institutions accepted an intrusive degree of oversight by the Banking Bureau. It fell to the Banking Bureau to ensure compliance with the system. At the center, the bureau saw to it that matters functioned properly. In large part, that meant making certain that each category of financial institution kept to its own area of expertise and did not intrude into the business monopolized by others. It also meant that no single financial institution within a particular category obtained an untoward advantage. The system, therefore, depended upon a Faustian bargain between industry and government. Financial institutions accepted limitations on operations but only because they were outweighed by the benefits. The cooperation and un­ derstood quid pro quo meant that they would often engage in behavior that seemed to defy economic rationality. Financial institutions would, at the request of the Banking Bureau, absorb sick banks, bad loans and all. They would, at the request of the Treasury Bureau, buy government bonds at below market interest rates. They would, at the request of the Secretariat, hire retired bureaucrats and pay them lucrative salaries even if they did little actual work. They would fund think tanks and data collection agencies and place them under the control of retired Ministry officials. In return for these costs, financial institutions received a steady supply of business, re­ duced lending risk and certain profitability. That did not mean financial institutions always agreed with the Ministry. Where an MoF inspired policy lacked industry-wide support, progress on reg­ ulatory reform was tortuously slow. This occurred, for example, in connection with the Banking Bureau’s effort to encourage consolidation within the financial system. Banks were generally not in favor of policies designed to lead to their demise. Smaller banks resisted entreaties to merge, particularly where they would be absorbed by a more dominant partner. Proud, larger banks rarely wanted to combine. Given industry resistance, consolidation occurred mostly when banks found themselves in financial trouble or where retired MoF officials within the banks encouraged the process. The fact that MoF officials wanted more rapid consolidation made no difference. Stability, sharply defined roles, and cooperation between regulator and reg­ ulated, therefore, were critical components of the postwar financial system. Par­ ticipants— whether bureaucrats or industry— viewed any type of destabilizing change with suspicion. Destabilizing effects could come from unexpected places.

52

Management, of the Financial Markets

The risk always existed in such a tightly regulated system that a financial insti­ tution might develop a new product or line of business that would result in a destabilizing advantage. To minimize the possibility, financial institutions were expected to preclear all impending developments with their respective bureaus. The bureau in turn would either block the practice, disclose it to other financial institutions, or act as a gatekeeper so that innovation did not destabilize. Bureaucrats often would go slowly in granting approval, in part to give other financial institutions time to catch up. The innovation would, therefore, quickly become an industry-wide practice, limiting the competitive impact of the new development. BANK LENDING AND INDUSTRIAL CONTROL When the occupation ended, the country still suffered from a severe capital shortage. With funds in short supply, Japan could not rebuild all industries simultaneously. At the same time, the country had inadequate foreign reserves. Not a convertible currency, the yen was useless in international markets. Re­ serves (read dollars) were essential to purchase the necessary imports, particu­ larly raw materials. The primary function of the Banking Bureau was to oversee the role of the financial system in the economic recovery. The system used to fund the war efforts would now be converted to fund the country’s redevelopment. In postwar Japan, banks would serve as conduits for distributing capital to corporate Japan. In effect, the use of bank financing allowed the government, rather than the market, to determine which segments of the economy received funding. The position of banks did not, however, occur naturally but arose out of the delib­ erate design of bureaucrats. The Capital Shortage and the Loan Priority System Capital rationing may have been the most significant device used to promote the country’s economic recovery. To generate additional foreign currency re­ serves, Japan needed to increase exports. Only a handful of industries had the immediate capacity to compete in international markets. They needed capital. With the market unequipped to ensure that these industries received an adequate supply of reasonably priced capital, the government stepped in. The postwar model, therefore, depended upon government policies displacing market forces. Relying on a market mechanism would have allowed all putative borrowers— whether basic industries, restaurants or consumers— to compete for funds by bidding up interest rates. Borrowers with no potential to generate for­ eign reserves would have acquired scarce capital, squeezing out industries deemed crucial to recovery. Government policies restricted the companies eligible for financing. Only those deemed critical to the country’s economic recovery would receive a guar-

The Postwar Financial System

53

anteed supply of capital. The system of allocating capital to specific industries and companies amounted to a deliberate reduction in competition for funds and ensured that they only ended up in the hands of key (read export) industries. Nor did the selection of appropriate industries require a crystal ball. Japan had a number of obvious and exploitable advantages, including an educated work force, low labor costs, and a passion for quality. Almost any labor-inten­ sive, high-quality product with a worldwide market would have sufficed. More­ over, Japan being in a “ catch-up” position with the industrial west, the technology for targeted industries was readily available, eliminating the lead time required for development. The process of allocating funds to key industries began during the occupation. With the capital shortage following the war, rebuilding the Japanese economy necessarily involved choices. Funds were not available to resurrect all sectors simultaneously. In response, the Supreme Commander of Allied Powers (SCAP) implemented the loan priority system in March 1947. Industries were catego­ rized in accordance with their importance to economic recovery, with coal and electricity receiving early emphasis. By the end of 1948, however, attention had shifted to export-related indus­ tries. Foreign exchange and profits generated by export sales would provide additional sources of capital and permit continued industrial expansion. Scarce resources were therefore funneled to textiles and other businesses capable of generating foreign exchange. At the same time, SCAP made clear that certain businesses, particularly those with a consumer orientation, should not expect funding. The First Solution: The Reconstruction Finance Bank The priority lending system dictated who would get the loans but did not ensure that they would be made in the first instance. Commercial banks were leery of lending funds to weak and unstable companies, a description that fit most of postwar Japanese industry. As industry struggled to recover from the war, most companies lacked the creditworthiness necessary to obtain loans. Banks were also subject to restrictions on loan volume in an attempt to control inflation. With commercial banks either unable or unwilling to make loans, the gov­ ernment opted for a direct solution, creating the Reconstruction Finance Bank (RFB). An expediency, the RFB amounted to little more than a governmentcontrolled vehicle for funneling capital to corporate Japan. Funds essentially came from the coffers of the central bank and were lent directly to Japanese businesses. The RFB had an extraordinarily broad and imprecise mandate, en­ compassing loans “ which, though necessary for promoting the reconstruction of national economy, are found difficult to be supplied by other ordinary finan­ cial institutions.” 1 The bank quickly became a critical fixture in the financial system. With ap-

54

Management of the Financial Markets

proximately half of the funds lent for equipment and the other half for opera­ tions, the RFB by March, 1949, was providing 32.3% of all bank loans.2 The RFB’s role in the Japanese financial markets was characterized by occupation officials as “ the most important single source of new credit since its establish­ ment in October 1946.” 3 The RFB, however, demonstrated the dangers of direct government interven­ tion. Nominally independent, the RFB was subject to heavy political influence. The bank was headed by a commission that included the scions of government, specifically the Minister of Finance, the governor of the Bank of Japan, and at least two other ministers. The make-up effectively politicized the RFB’s lending practices.4 In the words of one occupation official: It probably will have to be admitted upon careful reflection that this bank undertook an impossible task, and was left wide open to the type of corrupt development which has come to pass. A new organization with a very small staff completely subservient to a political commission and subject to the great pressure and confusion which is inherent in the present situation in Japan could not hope or be expected to make loans in an amount equivalent to one-fourth of the total loan position of all the financial institutions in the country, within the short hectic period of eighteen months, and do it on sound banking principles.5 The RFB, therefore, supplied much of the demand for corporate capital but did so in an unsatisfactory fashion. The system of bank financing that became a fixture in the postwar era emerged as a consequence of the allied decision to shut down the RFB. The decision primarily arose out of efforts to control inflation, although lending abuses also played a role. Funded almost entirely by the government, the bank essentially represented another conduit for moving yen from the printing presses to the economy. With the advent of the Dodge Line in 1949, SCAP ordered the RFB to cease operations. The cutoff in government funding for industry, coupled with the requirement of a balanced budget, threatened to cause a deflationary spiral. The unavailability of funds for coal and electricity raised the specter of an energy shortage. With the country’s industrial recovery in doubt, the government needed to find another source of funding for corporate Japan, one that did not conflict directly with Allied edicts.

The Second Solution: Commercial Banks Commercial banks became the answer. Commercial banks developed into a vehicle for channeling funds to Japanese industry mostly by default. An avenue left unobstructed by Dodge, the banks represented the only available mechanism once the RFB ceased operations. For commercial banks to provide capital to Japanese industry, three things

The Postwar Financial System

55

had to occur. First, banks had to have more funds. The deposit base was insuf­ ficient to supply industry’s needs. Second, the banks had to have greater assur­ ances of repayment. The sickly state of the Japanese economy made corporate loans a high-risk proposition. Third, companies needed encouragement to bor­ row and expand. The government addressed the first two concerns, the North Koreans the third. To alleviate the risk and encourage lending, banks received an implicit guar­ antee of repayment from the government. The government did so by ensuring that key businesses did not fail. Instead, where companies experienced reversals, they would be merged with a healthier compatriot within the same industry. In this way, banks were assured that their loans would never be in default. The next problem was funding. Japanese banks had a shortage of yen. Banks obtained a portion of the much needed funding from deposits. Another occu­ pation-inspired initiative, the Temporary Interest Rate Adjustment Law of 1947 gave the government the authority to regulate interest rates. The MoF used the power to keep interest rates low. With deposits receiving anemic returns, banks had a steady source of low-cost funds. The deposit base, however, was not enough. SCAP knew about the shortage of yen and favored giving all commercial banks the authority to issue bonds. Adopted in 1950, the Law Concerning Debenture Issues of Banks did exactly that. The legislation did not, however, work as expected, with most commercial banks not exercising the authority. In response, SCAP shifted gears. Rather than leave long-term lending to the banking system as a whole, a class of banks was set up specifically for that purpose: The step required a somewhat embarrassing policy shift.6 After all, the decision essentially resurrected the “ special banks” that had been carefully and deliberately eliminated. Nevertheless, economic ex­ igencies and Joseph Dodge compelled the return of long-term banks. With the long-term commercial bank distinction in place, the Bank of Japan expanded credit by 60% mostly in the form of low-interest loans to commercial banks. The added funds provided leverage. In return for access to the discount window, bureaucrats expected and received the right to review credit allocations by banks. The MoF used the influence to direct capital to key industries. Be­ holden to the government, banks confronted the risk that ignoring the MoF or Bank of Japan would affect the availability of the funds and profitability. With banks ready to lend but the economy in the doldrums, something was needed to spur demand. The Korean War accomplished that. To meet the de­ mands of U.S. military procurement, Japanese companies once again turned to banks for capital. With the spigot opened, loans by city banks climbed to 117% of deposits in 1950, and 124% the following year. Corporate dependency on banks and bank dependency on the government became a permanent fixture of the postwar financial system. With commercial banks dependent on the government for funds, the central bank used the leverage to control lending, a practice known as ‘‘window guid­ ance.” Originally applicable only to certain categories of banks, the Bank of

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Management of the Financial Markets

Japan gradually extended the guidance to others. Banks would submit to the Bank of Japan a schedule of expected lending activity on a quarterly basis. After studying the figures and considering economic issues, the central bank would determine an acceptable increase in lending, typically a percentage applied to all city banks. Equal treatment was critical. Banks were concerned with their relative rank­ ing, and any attempt to vary the percentage could have altered their standing within their designated compartments. While the percentage could vary among classes of banks, those in the top tier of the city banks received substantially identical treatment. Increases were told to each bank confidentially and infor­ mally. The central bank did, however, publicize the amount of the increase for particular categories of banks, viewing the information as a legitimate device to implement monetary policy. Window guidance affected the relationship between company and bank. Dur­ ing periods of tight money, the central bank reduced available funds, forcing banks to cut back on lending. Those companies with lead-bank relationships would typically not suffer loan reductions. Other, less important clients, how­ ever, could find funds unavailable. The possibility made companies leery of doing anything that would interfere with the lead-bank relationship and possibly threaten the flow of funds. It explained why foreign banks offering lower interest rates often found few takers from blue-chip companies in Japan. Window guidance did not always achieve perfect adherence. Whole categories of banks remained outside the system. Foreign banks represented an obvious exception. Regional banks did not become subject to window guidance until the early 1970s. Officials at the Bank of Japan estimated that in the late 1960s, only 65% of all bank loans were subject to guidance. The system also gave rise to manipulation and attempts to circumvent the limits. Perhaps most importantly, it encouraged unsound lending practices. In­ creases in lending were usually expressed as a percentage of the preexisting lending base. That encouraged banks to lend their full quota each quarter to maximize the size of the lending base. The practice of lending to meet a target caused few problems when large, healthy companies were capital-starved and the government guaranteed repayment. Problems would arise, however, when the guarantees ceased and banks had to seek more risky avenues to meet their quotas. In the postwar era, control over funding represented the single most important source of government influence over industry. Typically with lead banks, com­ panies had to accept intrusive oversight by financial institutions as a quid pro quo for guaranteed capital supplies. A retired bank employee often served on the company’s board and participated in the decision-making process. Moreover, with banks in daily contact with the MoF, information from corporate Japan often ended up in the hands of the bureaucrats. At the same time, the availability of adequate funds to lend was the most significant form of bureaucratic leverage over banks. The ability to increase the

The Postwar Financial System

57

deposit base depended upon the MoF’s willingness to authorize additional branches. Similarly, funds from the central bank represented a crucial component of the business of commercial banks. Both dictated positive relations with fi­ nancial regulators. CRISIS MANAGEMENT The MoF emerged from the occupation in an exalted position, with its au­ thority enhanced. The Ministry’s prewar competitors, the Interior Ministry and the military, had been vanquished. Similarly, the occupation left intact the war­ time measures that left the Bank of Japan in a subservient position. Even in the private sector, the zaibatsu banks, which had, before the conflict, been strong enough to resist the entreaties of financial regulators, no longer could. The MoF represented the most powerful source of authority in the financial markets. The few restrictions placed on the MoF’s authority during the occupation were eliminated once U.S. officials departed. The Securities and Exchange Com­ mission— the semiautonomous agency designed to regulate the securities mar­ kets—disappeared, with its functions transferred to the Treasury Bureau. Similarly, the MoF swallowed the Foreign Exchange Control Board, assuming direct authority over issues of currency exchange. Only the Fair Trade Com­ mission survived as an independent agency. The MoF, however, captured the agency, with retired bureaucrats— routinely serving as chairmen. The occupation saw no significant internal reorganization of the MoF. Few officials were purged. Those changes that did occur largely augmented the bu­ reaucracy’s authority, with legislation, for example, giving control of the entire budget formulation process to the MoF. The Banking Law of 1927 emerged unchanged, despite concerns by occupation officials, with the Bureau retaining broad, regulatory authority over the financial industry.7 As the postwar system descended, the MoF’s primary role was to oversee capital flows and ensure the proper functioning of the financial markets. The system worked smoothly, with only small changes needed at the margins. Re­ serve requirements for banks were added in the late 1950s; laws facilitating mergers adopted in the 1960s; and a deposit insurance scheme implemented in the 1970s. In general, however, the role was to oversee rather than revise. That did not, however, mean that the MoF’s role was static. Crises did occur, some threatening the stability of the financial system. The most notable was the near failure of Yamaichi, then the second largest securities firm, in 1965. Of­ ficials also had to handle the role of foreign banks, with their greater capitali­ zation, relative freedom from bureaucratic oversight, and ability to stunt the recovery of Japanese banks. Perhaps most importantly, however, the MoF had to manage the often ab­ surdly low level of foreign reserves. Used to purchase raw materials, equipment and other imports, the availability of dollars to some degree dictated the level of growth. Demand for dollars increased during periods of strong economic

58

Management of the Financial Markets

growth and decreased during slowdowns. When reserves declined to danger­ ously low levels, therefore, the government had to reduce economic growth. On some occasions reserves almost disappeared, sending Ministry officials scurrying for emergency sources of foreign credit. In 1961, the country under­ went a reserves crisis and was forced to turn to private banks for an emergency loan. The Japanese economy had undergone a downturn. After two straight years of current-account surplus, Japan experienced a substantial reversal. Through July 1961, the country ran a deficit of more than $700 million. Reserves dipped below $1 billion, a paltry level that created a serious financial crisis. At a meeting of the International Monetary Fund (IMF) in Vienna, Ministry officials approached three U.S. banks, Citibank, Bank of America, and Chase, for a short-term balance of payment loan. Those involved in the loan remember Finance Minister Mikio Mizuta nervously chain-smoking cigarettes. In general, banks were hesitant to make these types of unsecured loans. In this case, how­ ever, they altered their usual practice. Each of the banks had branches in Japan and had confidence in the creditworthiness of the country. They agreed to pro­ vide the government with $100 million, providing adequate supplies of hard currency to get past the crisis. Given these types of crises, the government needed to ensure that it had a steady supply of dollars, not an easy matter for a country recovering from a devastating war. The government initially turned to the World Bank and other international lenders for funds. By 1963, however, the country was ready to begin weaning itself away from international lending institutions and to return to the capital markets to borrow funds. The first step was to select an investment banking firm to assist in selling the debt. First Boston had just handled an offering for the World Bank, providing the underwriter with considerable prominence in international financial markets. The firm had also been pushing the Ministry to enter the capital markets. MoF officials therefore approached First Boston as well as Kuhn Loeb and Morgan Stanley, two stalwarts with a long history in Japan. Morgan Stanley declined to participate. First Boston and Kuhn Loeb decided to flip a 1000-yen coin to decide who would act as underwriter. Kuhn Loeb chose the Fuji Mountain side and lost the toss. Ministry officials heard later that Kuhn Loeb employees had flipped the coin innumerable times before the actual event in an effort to determine which side was more likely to appear. The offering did not go well. The interest rate paid on the debt was higher than that paid by the Danish government in an earlier issue. Ministry represen­ tatives in New York had a difficult time explaining to superiors in Tokyo why Japan had to pay more than Denmark. Moreover, when the debt was sold, First Boston succeeded in raising only about half of the expected sum. To avoid the embarrassment of an unsuccessful offering, Ministry officials quickly arranged a loan from U.S. banks. With the additional funds, they could truthfully an­ nounce that they had raised the full $30 million. Reserve crises would gradually become less serious. Government financial

The Postwar Financial System

59

institutions would increase their profile in international markets and succeed in raising funds. Japanese commercial banks also gradually reestablished their rep­ utation as creditworthy institutions, and were eventually able to raise dollars in New York or London. Nonetheless, until they succeeded in doing so, it was the MoF that had to guarantee that the country had enough dollar reserves to ensure a continued economic recovery. CONCLUSION The period from the end of the occupation through the oil crisis in the early 1970s represented the halcyon years for financial regulators in the MoF. Their authority was unequaled; their task clear. In the financial system, stability reigned. Competition was limited; the role of each class of financial institution fixed. Profits were more or less guaranteed and risk minimized. Banks during the period resembled less commercial lenders and more conduits for government-inspired financing, much like the role played by banks in command economies. As the economy would transform, the lack of skill at assessing risk would become glaringly apparent, particularly after the collapse of the speculative bubble in 1990. Although the MoF constantly tinkered with the financial system throughout the post-occupation period, the changes were refinements rather than fundamen­ tal revisions. They rounded out but did not significantly alter the contours of the financial system. The MoF only had to make sure that the system functioned adequately. In general, that meant devising consensus on modest reforms to the financial mar­ kets, ensuring that no single financial institution obtained a destabilizing com­ petitive advantage, and handling the rare crisis that occasionally surfaced. Bureaucrats within the MoF handled these functions with energy and ingenuity.

CHAPTER 5

The End of th e P o stw a r Financial S ystem

For 20 years the Ministry of Finance directed the flow of capital to critical industries. The bureaucrats in the MoF kept careful watch on the financial sys­ tem, making certain that nothing interfered with its well oiled machinery. Oc­ casional crises arose, such as the near collapse of Yamaichi, then the country’s second largest securities firm. Reserves constantly seemed on the edge of dis­ appearing. All in all, however, the system functioned smoothly, accomplishing its main goal. Japanese companies received an adequate supply of low-cost funding; fi­ nancial institutions made healthy profits; economic growth skyrocketed. Japan became the first country in the postwar era to prove the feasibility of sustained double-digit economic growth. By the 1970s, however, the postwar system of financial regulation had lost its central purpose. The explanation was simple: Japan’s capital shortage had ended and the economy had fully recovered. The entire financial system had been premised on the goal of getting capital to the companies that could most aid economic recovery. That, however, was no longer necessary. The change involved more than semantics. With the primary benefit gone, the limits of the system would be increasingly hard to justify. Despite the altered circumstances, the MoF was initially in no hurry to im­ plement dramatic change. Pressure for reform had not yet arisen from industry and the need for systemic reform had not become apparent. The MoF’s com­ placency with the status quo, however, came to an end as a result of a series of financial blows that brought the weaknesses in the financial system to the surface and gradually made clear the untenable nature of the existing system. The first oil crisis forced Japanese companies to cope with the effects of more restrained growth'. With growth rates halved, corporate Japan began to borrow

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less. Bank loans as a means of funding capital needs started an inexorable de­ cline. As the primary purveyors of capital, Japanese banks quickly felt the effects of the change in demand. With corporate business on the decline, banks wanted other sources of fees. Pressure, therefore, began to build to tear down the walls separating financial institutions. Comprehensive reform of the financial markets was no easy matter. Reform created winners and losers, with the prospective losers resisting any change. Trust banks wanted to retain their monopoly over asset management. Long-term credit banks wanted to maintain their monopoly over the sale of bonds. Small banks dependent on retail deposits opposed interest rate deregu­ lation. The most protracted and serious dispute, however, centered on the divide between banks and securities firms and, concomitantly, their respective bureaus. Above all else, banks wanted the authority to underwrite first government, then corporate, securities. Securities firms adamantly resisted any intrusion, not with­ out good reason. Securities firms asserted that banks would use their sizeable branch networks to make serious inroads into the securities business. More darkly, securities firms insinuated that lead banks would use their position to coerce companies into giving them the underwriting business. The approach played on the MoF’s pred­ ilection for preserving stability by protecting the weakest link in the financial system. The MoF also knew that the largest securities firms had substantial political connections and if unhappy with any resulting compromise would seek intervention. In the short term, therefore, the MoF had little interest in acceding to bank demands to enter the securities markets. Doing so would upset the carefully crafted financial system that had worked so well throughout the postwar period. Moreover, securities companies claimed that they were too weak to withstand the added competition. Implicit in their objections was their willingness to take their case to politicians if reform happened too quickly. Nonetheless, reform became inevitable. By the mid-1980s, the MoF had largely accepted the need to completely revamp the postwar financial system, including elimination of the prohibition on securities activities by banks. Al­ though the goal was certain, the means were not. The Ministry lacked sufficient opportunity for implementation. Making matters more complex, foreign pressure interfered with the orderly process, directly affecting the nature and pace of domestic reform. The task of altering the financial system resulted in a dramatic shift in the MoF’s role. Previously the enforcer of the status quo, a role widely supported by industry, the Ministry now had to engineer a complete overhaul in the reg­ ulatory system. It would find the process far more difficult and one that required considerably greater bureaucratic energy and ingenuity. The effort also demonstrated limits on bureaucratic authority. Notwithstanding immense authority and often imperious attitudes, the Ministry remained inca-

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Management of the Financial Markets

pable of dictating the evolution of reform in the financial markets in the face of intractable divisions. The compartmentalization that had contributed so sig­ nificantly to the development of the financial system had now become a source of paralysis. While the demise of the postwar financial system would represent one of the MoF’s most significant achievements, it also, ironically, carried the seeds of the Ministry’s fall from power. In the short term the MoF had increased authority, tightly managing the decompartmentalization process. In the long term, how­ ever, the reforms resulted in the creation of a class of powerful universal banks capable of remaining independent of the MoF’s guidance. THE INTERNATIONAL IMPETUS The first significant pressure for reform of the postwar financial system had its roots in the international financial markets. As the economy gradually recov­ ered, Japanese banks began to expand abroad, particularly in an effort to tap markets in the U.S. and Europe. Expansion abroad provided increased access to dollars, a scarce resource. It also, however, presented a conundrum for the MoF. While facilitating trade and access to dollars, international activity threatened Ministry control. The MoF simply could not exercise the same degree of tight oversight in foreign markets that it could exercise domestically. Nonetheless, the Banking Bureau had little choice but to allow some inter­ national activity, although subject to significant constraints. As with any do­ mestic branch, Banking Bureau approval was necessary to open a foreign outpost. Setting up an overseas branch also required the use of scarce dollars. They generally came from the Bank of Japan in the form of deposits, providing an additional source of bureaucratic leverage. The Ministry limited the number of banks that could have international offices and the number of overseas branches that each could open. Expansion abroad began almost simultaneously with the signing of the San Francisco Peace Treaty in 1952. That same year, 10 overseas branches and three representative offices opened. New York and London became the locations of choice. Early expansion reflected the particular needs of the government, with the first branches designed to handle repayments to prewar bond holders. The Bank of Tokyo initially had something approaching a monopoly on in­ ternational branches. The explanation was in large part historical. Before the war, the Yokohama Specie Bank, the predecessor to the BoT, had the most extensive network of international branches of any Japanese bank. The offices were closed during the conflict and eventually liquidated. As the successor, the BoT would be given preferences in the area of overseas expansion.1 The BoT essentially obtained the right of first refusal for any international branch. To the extent needing a branch in a particular country or foreign city, the MoF would first offer the opportunity to the Bank of Tokyo. Only if the

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bank refused would other Japanese financial institutions receive a comparable opportunity. Although the BoT obtained preferential treatment in the international sphere, the MoF imposed a stiff price. The BoT saw its domestic operations carefully limited. The BoT could only open domestic branches in cities involved in for­ eign trade and, within Japan, could make only trade-related loans. Denied an extensive network of domestic branches and, concomitantly, deposits, the BoT had difficulty raising funds. To address the problem, the BoT was given the authority to issue debentures in 1962. With the BoT’s limited domestic deposit base, authority to sell debentures only upon approval, and government control over foreign branch openings and dollar deposits, the MoF retained considerable influence over the international financial institution. The BoT was widely viewed in the financial community as exceedingly close to the government, as had been the Yokohama Specie Bank before the war. Indeed, the Bank of Tokyo always retained a retired official from the Bank of Japan or MoF in an executive management position until its merger with Mitsubishi in the 1990s. City banks also received authority to expand abroad, although on a far more limited basis. They had to provide the MoF with a schedule of planned openings. With the Banking Bureau acting as traffic cop, banks were generally permitted one overseas branch every three years. Expansion was initially limited to the top tier of city banks and permitted only in London or New York, although Sumitomo and the Bank of Tokyo were allowed to operate subsidiaries in Cal­ ifornia. By 1970, Japanese banks had a total of 57 foreign branches, almost half held by the Bank of Tokyo. Only in the 1970s did the MoF allow long term credit, trust and regional banks to open their first overseas branches. Thereafter, ex­ pansion accelerated. By decade’s end, the number had increased to 123, with more than 200 additional representative offices and banking subsidiaries. Al­ though most were located in Europe and North America, Japanese banks also built up a sizeable presence in Asia and the Middle East. At least initially, the MoF viewed expansion into the euromarket with a jaun­ diced eye. With limited international experience, Japanese banks lacked the ex­ pertise to operate in the largely unregulated market. Moreover, in Japan they had no tradition of making longer-term loans, something that occurred regularly in the euromarkets. The Ministry was also concerned that some banks would engage in risky activities that would harm Japan’s financial reputation, no small matter for a country still widely viewed in third world terms. Finally, activities in the euromarkets threatened to generate conflict between brokers and banks. The MoF, therefore, applied liberal amounts of guidance to the activities of Japanese financial institutions in the euromarkets. When banks and securities companies wanted to engage in medium-term lending, something they did not do in the domestic market, the MoF conditioned approval on entry into a con­ sortium bank or a joint venture with a foreign financial institution. The approach

64

Management of the Financial Markets

reduced the risk to any single financial institution and provided a mechanism for obtaining expertise. The MoF’s concerns ultimately proved prescient. With the first oil crisis, the inexperience of Japanese banks became embarrassingly apparent. Banks had raised short-term supplies of dollars and used them for medium-term loans in the euromarkets. The oil crisis created a dollar shortage, with short-term markets evaporating. The BoJ made things worse by borrowing heavily in the market to pay increased oil bills and by withdrawing foreign currency deposits from Jap­ anese banks. To meet existing commitments, the banks had to borrow heavily and pay a “ Japan” premium, reflecting the collective decision of the markets about the declining credit-worthiness of these borrowers. Shocked, the MoF reacted by overreacting. The Ministry sharply clamped down on overseas activities. A handful of representative offices aside, Japanese banks were prohibited from opening additional foreign offices. International joint ventures came under heavy scrutiny. Medium- and long-term lending in the euromarkets was essentially banned, and the percentage of any syndicated loan held by Japanese banks limited. The Ministry gradually removed the con­ trols, lifting the last ones in 1978. Activities in the euromarkets represented the first efforts by the MoF to man­ age the behavior of financial institutions in an essentially unregulated market. The example portended the types of difficulties that would arise in the domestic markets. The reality was that the Ministry could not control events and gradually had to cede any pretense of doing so. At the same time, activity abroad began to seep back into the Japanese fi­ nancial markets. Financial institutions obtained experience with deregulated in­ terest rates and long-term lending. Pressure would grow for permission to use these skills in the domestic market. Reform-minded bureaucrats learned to ma­ nipulate the relationship between domestic and international markets, aware that liberalization in the euromarkets would ultimately reverberate back into domes­ tic markets. THE DOMESTIC IMPETUS It was the impact of the first oil crisis on the domestic economy, however, that represented the most immediate catalyst for the unraveling of the postwar financial system. The crisis represented a dividing line in Japan’s economic development. The event effectively marked an end to the country’s recovery phase. Growth slowed from double to single digits, changing corporate attitudes toward the costs of capital. The crisis shattered the carefully crafted, carefully sheltered postwar financial system. With the economic transformation of Japan underway, the postwar fi­ nancial system could not remain static. Although the outmoded nature of the system became apparent following the first oil crisis, it would take a series of blows and crises before the MoF would recognize that systematic dismantling

The End of the Postwar Financial System

65

was necessary. Once the realization dawned, however, the bureaucrats set about to do exactly that. The Bond Syndicate A seemingly technical and esoteric area, changes in the system for selling government bonds represented the beginning of the end of the postwar financial system. The system began to unravel, therefore, not because of visionaries in the financial bureaus, but because of the more immediate need to fund the gov­ ernment’s deficit. The Budget and Treasury bureaus, rather than Banking and Securities, could lay claim to initiating the end of the compartmentalized finan­ cial system. One of the most immediate consequences of the oil crisis was a burgeoning budget deficit. Even before oil prices skyrocketed, Prime Minister Tanaka had browbeat the MoF into accepting larger budgets. The oil crisis, however, resulted in an economic slowdown and caused a decline in tax revenues, exacerbating the deficit. The deficit forced the Ministry to devise new mechanisms for raising the funds needed to cover the shortfall. The money had to come from somewhere and the answer was to be deficit financing. The approach conflicted with tradition, his­ tory, and law. Ever since the Dodge Plan in 1949, Japan had a history of bal­ anced budgets. With revenues matching expenditures, the government had no need for deficit bonds. Only in 1965 did the government abandon the balanced budget requirement, issuing bonds the following year. Even then the fiction arose that the bonds were not designed to finance shortfalls in the general account budget but were for public works and other infrastructure projects. Categorized as construction bonds, the explanation was a sleight of hand; bonds used to pay for public works freed funds in the general account. With the oil crisis, however, even that fiction ended. The bonds were issued to cover deficits in the government’s general account. Bond sales before the oil crisis had been modest in amount and financed through a syndicate consisting of banks, insurance companies, securities firms and other financial institutions. Like everything else in the financial system, the process was subject to tight control. Rather than permit resale of the bonds, the Bank of Japan would repurchase the instruments after a one-year holding period. Rather than pay a market-determined interest rate, the Treasury Bureau nego­ tiated rates with the managing underwriter of the syndicate, typically a city bank. With a judicious use of administrative guidance, the Bureau could dictate the terms of the bonds, paying below market interest rates. The contrived system of sales represented a bald attempt to manipulate the financial system to finance the deficit at below market rates. Syndicate members purchased the bonds to help maintain positive relations with the government or, more crassly, to avoid the enmity of the MoF. As long as the amounts remained

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Management of the Financial Markets

modest, they viewed the purchases as a cost c f doing business. Moreover, resale to the government after a one-year holding period meant that financial institu­ tions did not have to suffer through volatile shifts in the value of the principal. All in all, the purchase of the bonds came at a tolerable cost and an acceptable amount of risk. In the 1970s, however, this placid state of affairs crumbled. Deficit spending and, concomitantly, bond sales, exploded. The huge volume threatened to and did overwhelm the existing system. Pressure became intense for bonds with a competitive interest rate and for a secondary market in government securities. A secondary market inevitably meant entreaties from banks for underwriting authority and territorial conflict with securities firms, something that the MoF did not want to confront. With volume increasing, syndicate members became unhappy at the low in­ terest rates paid on the bonds. The Treasury Bureau instituted a number of modest reforms in an attempt to assuage the concerns, including the sale of shorter-term instruments. These efforts, however, proved inadequate. What syn­ dicate members wanted was a market interest rate. Nonetheless, the bureau resolutely refused to increase interest rates. In the end, the syndicate began to take uncharacteristically direct action, including public disputes with the MoF. Conflict surfaced in January 1979. Unable to obtain an increase in interest rates, the syndicate settled for a reduction in volume of the monthly issue of bonds. This was not a permanent solution, and unhappiness with below-market rates continued to fester. In March, talks broke down completely. Only after intervention by the Prime Minister did the MoF ultimately increase the interest rate. Nor would this be the last time. Disputes over interest rates would occur repeatedly during the next two years. In the short term, the Treasury Bureau could sidestep the syndicate’s objec­ tions by selling the bonds to captive audiences such as the Trust Fund Bureau, a source of funds it controlled. The government, however, could only absorb so much. As long as resistance continued, the only solution was to reduce the amount of debt or raise interest rates. Tilting to reality, the MoF eventually chose the latter. Government bonds had to pay something approximating market interest rates. The era of interest rate deregulation had begun. Similarly, the increased volume caused the Bank of Japan to cease repur­ chasing bonds following the one-year holding period. Banks were therefore stuck with increasingly large volumes of government debt. Still raising most of their funds through short-term deposits, banks were now forced to keep them locked up in long-term (ten-year) government debt, a volatile and unhealthy situation. As pressure grew, the Treasury Bureau ultimately abandoned the prohibition on resales, allowing syndicate members to unload bonds in their portfolio. The right to resell government bonds reignited the smoldering conflict between bro­ kers and banks. As companies reduced borrowing or turned to overseas sources,

The End of the Postwar Financial System

67

banks saw their traditional business decline. Selling government bonds to in­ vestors represented an additional source of income. Banks, however, found themselves locked out. Article 65 of the Securities and Exchange Law continued to prohibit banks from engaging in securities activities. They could not, therefore, sell the bonds. Even worse, they had to sell them through their archrivals, the securities firms. City banks in particular remained unhappy with the situation. As usual, the MoF tried to sidestep the issue. Banks received limited rights to resell the bonds, although only to a select group of purchasers such as foreign governments. The modest liberalization proved inadequate and pressure contin­ ued to build for full underwriting authority. Not until 1981 and amidst much controversy was the issue finally resolved. Even then, the compromise worked to the disadvantage of banks. Changes in the bond syndicate caused the first significant fissures in the com­ partmentalized financial system. Interest rate deregulation commenced, with bonds now paying something approaching a market rate. It would only be a question of time before private-sector financial institutions demanded and re­ ceived comparable authority to set competitive interest rates on deposits. Sim­ ilarly, agitation to end the compartmentalized financial system had begun, particularly the separation between banks and securities firms. The process would consume the bureaucracy and the financial industry for the next 20 years.

Interest Rates The oil crisis affected more than banks and securities firms. Corporate Japan began to borrow less. With growth rates- down, managing cash reserves became more important. Yet companies had few investment alternatives. The funds were deposited with banks, receiving the traditionally low returns. Acceptable in the days of capital shortages, the practice had now become intolerable. Companies wanted bank instruments that paid a market rate. Agitation for the deregulation of interest rates, a pillar of the postwar system, came from a host of sources. City banks and, significantly, for the first time, foreign banks, all had incentive to push for the reform. City banks saw the instrument as a mechanism to stem the decline in deposits. Foreign banks, tra­ ditionally foreclosed from an adequate supply of yen, wanted an unregulated product to better compete for deposits. In determining whether banks could issue market-rate certificates of deposit, the Banking Bureau had little concern over competency, at least for the largest banks. City banks had been issuing certificates of deposit overseas since the 1960s. Given such considerable experience, the introduction of certificates of deposit into Japan turned less on prudential concerns and more on forging the necessary consensus among affected segments of the financial system, with the MoF serving as intermediary. Early attempts at deregulation generated consid­

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Management of the Financial Markets

erable opposition. Each segment of the financial system argued that it would be harmed by the reform. The process of reform took most of the decade. The authority to issue certif­ icates of deposit only arrived in 1979. Moreover, the resulting change illustrated the consensus-building process in practice. The MoF allowed commercial banks to issue certificates of deposit, but with a Solomon-like compromise designed to address the myriad of objections. The instruments could only be issued in large denominations, were non-negotiable, and had short-term maturities of be­ tween three and six months. The large denominations meant that the instruments would not attract small depositors, the core business of local banks. Non-negotiability and short dura­ tions avoided direct competition with debentures issued by long-term credit batiks. The limitations on negotiability also appeased securities firms by mini­ mizing competition with the gensaki market. Even foreign banks received mu­ nificence from the MoF. They could initially issue larger quantities of the certificates than Japanese banks. The process, therefore, provided a bit of some­ thing for everyone. Of course, the resulting compromise demonstrated another aspect of the re­ form process. The changes were fundamentally anti-consumer. Small investors could not afford to buy the large-denomination certificates. Large investors could, but were limited to short durations and subjected to prohibitions on resale. The MoF’s efforts at reform were more designed to appease crucial segments of the financial industry than to introduce rational, pro-consumer financial prod­ ucts. With the reforms, pressure for additional interest rate deregulation abated. Serious proposals for continued reform returned to center stage only when they emerged as a bilateral trade issue in the early 1980s. U.S. negotiators contended that the low cost of funds brought about by interest rate controls allowed Jap­ anese banks to underprice foreign banks. With a lock on the domestic market, Japanese banks could pursue low margin areas abroad. Despite sharp negotiations in 1984, however, the MoF gave only modest ground. The Banking Bureau agreed to lower the minimum denomination for certificates of deposit and permit the introduction of other market-rate instru­ ments. Bureaucrats adamantly refused to concede a specific date for complete decontrol. This inability reflected fierce objections from within the financial community, particularly from smaller financial institutions dependent upon retail deposits and, more importantly, from the agricultural cooperatives, a specialized class of financial institutions with exceptionally well developed political con­ nections. Only when consensus was reached in 1989 on a gradual process of decontrol with the agricultural cooperatives could a final date for complete de­ regulation be announced. Deregulation of interest rates, more than any other single reform, permanently fractured the system of financial regulation in Japan. Banks could now compete for funds without relying on the guiding hand of the Ministry. New branches— a

The End of the Postwar Financial System

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key source of Ministry control in the postwar era— became less critical, with banks able to obtain deposits through price competition rather than the opening of additional offices. Moreover, as decontrol caused some banks to edge closer and closer to in­ solvency, the MoF was forced to react. The decision to decompartmentalize the financial system came in large part as a result of the need for banks in different categories to step in and save failing financial institutions. That could only occur in a deregulated environment. UNFINISHED BUSINESS Following the oil crisis, the MoF found itself trying to deal with an increas­ ingly dysfunctional postwar financial system. Reform initially occurred in a piecemeal and ad hoc manner. The MoF engineered changes to address the crisis of the moment but otherwise left the system fundamentally intact. As compartmentalization became increasingly untenable and counterproduc­ tive, the finger-in-the-dike approach ultimately had to give way to more com­ prehensive reform. Sometime in the 1980s, the MoF made the philosophical decision to eliminate the postwar financial system. It took 10 years to achieve the result and bring the process to closure. The decision to engineer the transformation dramatically changed the role of the MoF in the financial markets. As long as the compartmentalized system functioned, the MoF’s role was primarily as enforcer of a system accepted by all significant participants. The MoF made certain that financial institutions did not engage in competition outside of their designated compartments and did not obtain an excessive advantage over those within their compartments. Bringing an end to the compartmentalized financial system, however, involved an entirely different set of considerations. Reform in the postwar system had been a mild affair. Most reforms were widely supported by industry (perhaps the addition of reserve requirements being the only significant exception), did not materially affect the business of financial institutions, and were subject to broad agreement and consensus. Dismantling the postwar system, however, meant that categories of financial institutions would lose their carefully protected monopolies. While some would look forward to the additional authority, others knew they would have trouble surviving in a deregulated market. Whole categories were at risk, with long­ term credit and trust banks unlikely to survive. Yet the rules requiring consensus still applied. The MoF had the difficult and unenviable task of reaching consensus with categories of financial institutions that saw no benefit from deregulation. Moreover, the broad support for the MoF’s activist role as enforcer did not transfer to its role as dismantler. The MoF found itself in the middle of a maelstrom, trying to engineer reform over strong opposition. Moreover, while the decision was made to jettison the postwar financial sys-

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tem, the MoF did not make a similar commitment to update its own approach to regulation. The MoF accepted the need for financial reform but not the con­ comitant and inevitable reduction in its own authority. Thus, as markets became more deregulated and competitive, bureaucratic reform failed to keep pace. The MoF would gradually learn that a postwar bureaucratic state and a decompartmentalized financial system were incompatible. It would be a difficult and em­ barrassing lesson.

CHAPTER 6

Too Close for Com fort: The S ecu rities B ureau an d th e S ecu rities Industry

The most protracted fight in the dismantling of the postwar financial system centered around the divide between banking and securities activities. Securities companies had little interest in allowing banks into their area. Yet as matters continued to evolve within the Japanese economic system, the separation became increasingly damaging to the financial markets. Elimination of the wall that separated the two industries showed the limits on both the Ministry of Finance’s ability to engineer change and on the skill with which bureaucrats ultimately achieved their objective. Reform required a re­ lentless process of developing a consensus, assiduous use of foreign pressure, and the timely appearance of scandal. Nonetheless, the process still took 20 years to complete. Part of the difficulty arose from the excessively close relationship between bureaucrats and industry. More than in any other bureau, the Securities Bureau had become dependent upon the Big Four, particularly Nomura, for expertise and policy implementation. Bureaucrats within the bureau were, therefore, par­ ticularly unwilling to take steps opposed by its primary constituency. The close relationship between the Securities Bureau and the securities in­ dustry resulted in perhaps the most damaging scandal to engulf the MoF in the postwar period. The compensation scandal, which erupted in 1991, showed that industry had been protecting large clients from losses in the stock market, with ordinary investors obtaining no comparable protection. The Securities Bureau knew what was going on and only tried to stop the practice after it had become too late. The scandal demonstrated that the rules of engagement had changed. In many ways, the Securities Bureau had merely been engaging in business as usual. It had allowed a practice to continue that benefited business at the expense of

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consumers. A basic premise of the postwar system, the approach explained nu­ merous policy decisions emanating from the bureaucracy. Times had changed, however, with the postwar system in decline. Traditional approaches were no longer acceptable, as the bureau was about to discover. The compensation scandal was in many ways an extreme example of the MoF’s overall approach toward regulation: excessive closeness to industry and anti-consumer policies. Whatever else the compensation scandals taught, they showed that the interests of small investors did not receive much attention in the decision-making process. The scandal also demonstrated that excessive closeness to industry could redound to the detriment of the MoF in a very demonstrable way. The MoF’s handling of the scandal led to serious calls to break up the powerful Ministry and generated the first significant internal re­ forms since the 1960s.

DEVELOPMENT The securities industry had always represented the stepchild in the Japanese financial markets. Many securities companies only narrowly survived the oc­ cupation and did so in part because of the forced eviction of banks from the securities markets. Survival resulted more from the efforts of SCAP than the MoF. Securities firms existed in prewar Japan. Most began by buying and selling commodities or foreign exchange. Shortly after the turn of the century, they participated in, and eventually managed, government bond syndicates. The fore­ runners of Daiwa and Yamaichi Securities developed a specialty in underwriting government bonds and corporate debentures. Other securities companies had their roots in the banking industry. Nomura formed from the securities depart­ ment of Nomura (later Daiwa) Bank. The Industrial Bank of Japan participated in the formation of Nikko. Particularly after the financial panics of 1927, underwriting was limited to the largest securities firms. As the country went on a war footing, however, the use of equity financing as a mechanism for raising capital declined. The government shifted to bank financing as the principal means for funding industry, facilitating control. By 1945, industry received 93% of all funds in the form of bank loans. Securities firms emerged from the war in a weakened state. Their principal source of business— the stock exchange— had been closed. As with the financial industry in general, stock exchanges during the war went through a process of enforced consolidation. At the beginning of the occupation, only the Japan Se­ curities Exchange remained, with all other regional exchanges eliminated. A central exchange allowed the government to control the capital-raising process. The Japanese government closed the exchange just before the end of war. With concerns about the excessive degree of government control over the cap­ ital-raising process, Allied officials declined to reopen the exchange. Not until

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May 1949, after the adoption of the Securities and Exchange Law and the cre­ ation of a specialized securities regulator, did SCAP relent. That did not mean trading activity had ceased. Shareholders still existed. The break-up of the zaibatsu flooded the country with shares. Trading was specu­ lative, secretive and full of abuse. Securities firms had, therefore, an unsavory reputation, with occupation officials viewing their activities warily. As one Al­ lied official described: “ Although these [securities] dealers were licensed by the Government they had wide latitude for managing their business and little regard for Occupation policies and ethical business practices.” 1 With the markets closed and their financial condition weak, securities firms as an independent class of intermediaries were threatened with extinction. Prob­ lems with the solvency of securities companies continued throughout the oc­ cupation. Concerned about their viability, the Bank of Japan raised with occupation officials the possibility of mandatory consolidation. The central bank described the position of securities firms as “ very bad,” with the markets facing “ a total collapse.” As a solution, it called for a consolidation of the industry, eliminating one third of all securities companies.2 The industry survived, but only because of legislative intervention and support from occupation officials. At the insistence of SCAP, the Diet added Article 65 to the Securities and Exchange Law. The provision barred banks from engaging in securities activities. Although imported directly from the United States, home of the Glass-Steagall Act, the requirement had an entirely different purpose. The two industries were separated solely to prevent city banks from monopolizing the securities industry. Concern existed among occupation officials that the relatively small number of large commercial banks, particularly the former zaibatsu banks, would dominate the financial system. The separation ensured that banks would not be able to control the securities markets and that a new class of financial intermediaries would develop. Although ensured of survival, the securities industry was viewed by regulators as a second-class industry. One sign of its low status was the abbreviated history of the Securities and Exchange Commission, an organization designed to reg­ ulate the securities markets. The institution was created at the insistence of occupation officials. They wanted effective regulatory oversight before allowing the stock markets to reopen. Modeled somewhat after the National Tax Agency Administration, another creation of the occupation, the Commission was to be run by a three-person commission appointed by the Prime Minister but subject to considerable inter­ action with the MoF. The head of the Commission was viewed as having the rank of a director general of a bureau. For a brief time, therefore, the securities industry had regulatory parity with its banking counterparts. This did not, however, last long. Biding its time until the occupation ended, the MoF wasted no time in eliminating the Commission. In August 1952, the Commission was reduced to a division of the Treasury Bureau. The securities

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industry would not again get its own regulator until 1964 and would not be subject to the oversight of a semi-autonomous organization within the MoF until 1992. THE SECURITIES BUREAU AND THE SECURITIES INDUSTRY For most of the postwar period, the attitude of regulators toward the securities industry was both condescending and overprotective. Given these early and in­ itially legitimate concerns, the need to protect the industry evolved into a bu­ reaucratic mantra. Every time changes in the regulatory scheme were proposed, the industry would object, claiming that it was not yet ready for the competition. The argument was particularly successful with bureaucrats overly concerned with keeping the compartmentalized financial system intact. A Second-Class Industry In the financial markets, the securities industry represented a low-status in­ dustry. Some of the explanation was historical. Securities firms had only a sec­ ondary role in the country’s postwar economic recovery. External corporate funding came almost entirely from banks. Little use was made of public markets to raise capital, with few stock offerings taking place. In collusion with banks, the MoF discouraged and severely restricted the use of equity by corporate Japan. Freely accessible capital markets would have al­ lowed companies to sidestep banks and avoid the government’s system of loan priorities. Tight reign was therefore kept on access. An offering required bu­ reaucratic approval, something only rarely given, with the government limiting the equity markets to the largest and most stable companies. Even underwriting bonds, an area left to securities firms, was indirectly con­ trolled by banks, particularly the Industrial Bank of Japan (IBJ). Under the lead commission bank system, the IBJ would act as trustee for the bonds. The banks, rather than securities firms, would determine the terms of a corporate bond issue. As trustees, banks also received a portion of the proceeds generated from the activity. Less important, not as easy to control, and involving higher risk, securities markets generally had a reputation as a place for speculators and kabuya (stock peddlers), a term having an almost pejorative meaning. The securities business also seemed to involve a greater threat to the stability of the financial markets. Until the wave of bank failures of the early 1990s, the worst financial crisis confronted by the MoF in the post-occupation era concerned the near collapse of Yamaichi Securities Company, then the country’s second largest. This near failure showed the greater risks arising out of the securities markets. In the early 1960s, speculation and a wave of public offerings had pushed up the stock market. Between 1955 and 1961, the Nikkei average increased by

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more than 300%, and annual volume by more than 12 times, from 3.8 billion to 48.3 billion shares. When credit was tightened, however, the market fell. The decline was worsened by companies issuing new shares in an effort to compen­ sate for the reduction in bank loans. In an attempt to prop up the stock market, the Ministry supervised the creation of the Joint Securities Corporation. The entity was primarily funded by loans from commercial banks and the central bank and would intervene to purchase shares any time the market fell below comfortable levels. The MoF also sought to reduce the supply of shares by prohibiting additional public offerings. The markets stabilized but the intervention did not save Yamaichi from near insolvency. The second largest securities company, Yamaichi avoided failure only because of a government-inspired bailout. In May 1965, the company re­ ceived ¥28 billion in emergency loans from the Bank of Japan, with additional funds given to Ohi Securities in July. A failure might have precipitated a systemwide financial crisis, perhaps even affecting banks, no small matter given the absence of deposit insurance. The MoF had known about the deteriorating financial condition of Yamaichi but, in what would portend a common approach to financial crises, kept the matter secret, leaving the public unaware. The Ministry instead tried to play for time, hoping that a recovering stock market would resolve Yamaichi’s problems. Only when word of Yamaichi’s financial health was leaked to the public were more affirmative steps required. The MoF’s reaction to the crisis was harsh. In the aftermath of the near collapse, regulation of the securities industry was tightened substantially. Instead of simply registering, securities companies now had to apply for a license to operate. The Ministry used the new-found power to shrink the size of the se­ curities industry, with the number of firms falling from 1127 in 1949 to 277 in 1968, when the licensing system went into effect. In addition, the Ministry tightened regulatory oversight. First, the Securities Bureau was created. What had been a division of the Treasury Bureau was now elevated to bureau status in June 1964. By creating a specialized office with bureau rank, the MoF sent a message that the industry would now be placed under heightened regulatory supervision. Second, high-ranking officials were inserted into key positions throughout the securities industry. The single most important post captured by the MoF was the head of the Tokyo Stock Exchange. Responsible for the rules governing trading activities, the TSE regulated the behavior of securities companies. It was, therefore, in a position to affect industry-wide behavior. From its reopening after the war, the organization had been headed by rep­ resentatives of industry. Following the financial crisis and near failure of Ya­ maichi, the president of Nomura, Minoru Segawa, asked the MoF to assign the position to someone who would help restore credibility to the industry. As a result, the post went in 1967 to Teiichiro Morinaga, a former vice minister and

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future governor of the Bank of Japan. Thereafter, only retired vice ministers would be allowed to head the Tokyo Stock Exchange. Ministry officials also landed in other positions, including think tanks and trade associations. By the early 1990s, more than 30 high-ranking retired min­ istry officials held positions in the securities industry. The diaspora was itself not unusual. What was unusual, however, was the number of influential retired vice ministers who ended up in the securities industry and their general lack of industry experience. The network allowed the MoF to have a continuing say and critical obser­ vation posts in the securities industry, enhancing Ministry influence over broker behavior. In time, however, the practice would have the opposite effect. Rather than controlling the industry, amakudari gave the industry accentuated access to the MoF. With the industry populated by retired vice ministers, they could sometimes be induced to intercede at the highest levels of the MoF on behalf of securities companies. While officials from the Big Four had MoFTans who traveled to the Securities Bureau daily, they sometimes needed opinions expressed discretely to top officials, a task often left to retired vice ministers. Gradually, the securities industry grew in size and importance. By the 1980s, securities firms, led by Nomura, rivaled banks in profitability and political in­ fluence. In 1987, Nomura found itself the most profitable company in Japan, seizing the title from Toyota. This partly reflected the growing importance of the stock markets. Soaring to almost ¥40,000 by the end of 1989, the market’s upward trajectory seemed inexorable. Nomura even predicted the market would climb to ¥80,000. The growing importance of the securities markets did little to change the reputation of the industry. To the mandarins within the MoF, it still amounted to a second-class industry. The attitude could be seen in the pattern of post­ career appointments of Ministry officials. While they fought for positions in banks, they continued to refuse amakudari positions at securities firms. A Second-Class Bureau Consistent with the industry it regulated, the Securities Bureau was viewed within the MoF as a second-class bureau. Along with the Customs and Tariff Bureau, it was one of the few that could be headed by a non-Todai graduate. The director general would ordinarily be chosen last among the major bureaus. Low status had a number of explanations. In a country that venerated age, the Securities Bureau was the youngest. It also flowed from the relatively mar­ ginal status of the industry that the bureau regulated. The low status within the MoF meant that the high flyers traveling to the top administrative positions rarely spent much time within the bureau. Often bu­ reaucrats assigned to the bureau wanted out as quickly as possible, before per­ manent damage was'done to their careers. Similarly, those placed in the most

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influential industry positions rarely if ever came from the Securities Bureau. The president of the Tokyo Stock Exchange did not come from the Securities Bureau but from the ranks of retired vice ministers, someone almost guaranteed to have no industry experience. Nor did officials in the Securities Bureau attain the top positions in the MoF. No director general was ever elevated directly from the Securities Bureau to administrative vice minister, although two did serve in the position before mov­ ing on to more common stepping stones.3 As a result, industry influence over the bureau continued to grow. With the industry increasingly complex, particularly with the introduction of securitiza­ tion and derivatives, officials within the bureau had no industry experience and no immediate mechanism for keeping up with, and grasping, these develop­ ments. The result was that officials within the bureau relied upon and became more dependent on industry for expertise. Securities firms were also increasingly necessary for policy implementation. With the growing importance of the securities markets in the economy, the Big Four had become critical to the implementation of bureau policies. To the extent problems developed in the stock market, securities firms could be counted on to help. An example occurred in October 1987 when the Securities Bureau turned to them to create demand and reinflate the stock market. In contrast to New York and Fondon, the worldwide crash in stock markets had only modest effects in Japan. They also helped the MoF maximize revenues from the sale of public cor­ porations privatized by the government, something critical to a bureaucracy des­ perately trying to balance the budget. Shares in Nippon Telegraph, Japan Tobacco and Japan Railways were all sold to the public. To maximize revenues, the MoF counted on the Big Four to spur demand. Shares were often placed by the securities firms at high prices, only to fall a short time later. Securities firms could also play a role in the rescue of Japanese companies in financial trouble. If requested by the Ministry, the securities firms would place the corporate debt or stock needed to rescue a failing company. As a result, the securities firms, particularly the Big Four, had become important players in the financial system, something they were all too willing to convey to bureaucrats in the MoF. With a highly concentrated industry prone to occasional destabilizing behavior and undergoing rapid evolution, and in the absence of sufficient expertise or private-sector experience, the Securities Bureau inevitably became more de­ pendent upon the influence of the Big Four, particularly Nomura, in the development of policies for, and the regulation of, the capital markets. In return for the assistance, the securities firms expected the bureau to reflect their inter­ ests. The bureau, therefore, developed a highly symbiotic relationship with in­ dustry and resisted reforms that would allow increased competition, particularly from banks. With increased influence, the securities industry became less complacent in

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its relationship with the MoF. The Big Four had a commanding position in the industry and knew it. The top four securities companies collectively controlled a larger portion of their industry than their counterparts in the banking industry. With such influence, they could resist Ministry entreaties and take a less humble attitude when dealing with the career officials within the Securities Bureau. Nor was there much the bureau could do about it. The attitude could be seen from the way Nomura tried to start a trust company in the early 1980s. Trust companies had existed before the war. Most of the survivors, however, had converted into trust banks during the occupation. While trust companies disappeared, the law governing them remained on the books. Nomura decided to take advantage of the largely ignored law and seek a trust company license from the MoF. The securities firm knew that the effort would generate huge controversy. It effectively involved an effort by Nomura to enter an area left entirely to trust banks. Such a significant breach in the compartmentalized financial system, par­ ticularly by a securities company, would wreak havoc and would not be accepted lightly by the banking sector. Aware of the inevitable controversy, Nomura asked Morgan Guaranty, a bluechip U.S. bank with an office in Tokyo, to participate in the effort. In bringing the matter to the MoF’s attention, Nomura did not opt for the usual bottom-up method of obtaining approval. Instead of carefully negotiating with the relevant divisions within the relevant bureaus, Nomura went right to the top and sched­ uled a meeting with Noboru Takeshita, the finance minister. To the irritation and discomfort of MoF officials, Nomura revealed the purpose only a few days before the scheduled event. When the efforts became public, pandemonium broke loose. The proposal predictably drew virulent opposition from trust banks and from commercial banks which opposed the expanded authority for securities firms. The MoF ultimately denied the application. Nonetheless, bureaucratic annoyance with No­ mura’s disrespectful approach was palpable. Officials made clear that if Nomura did not drop the matter, the system of fixed commissions would become a topic for reform in negotiations with the United States, another example of gaiatsu or foreign pressure. The industry had become more important but was still overseen by a secondclass bureau. Securities firms had lost the humbleness and obeisance that had prevailed after the financial crisis of the mid-1960s, when representatives from industry had to beseech the MoF for a retired official to run the TSE. While bureaus within the MoF sometimes became dependent upon those they regu­ lated, it was not something to flaunt, a lesson Nomura would eventually learn. As a result, the Securities Bureau had what could only be described as an overprotective attitude toward the industry it regulated. The attitude was rein­ forced by the dependency of the bureau on the Big Four to control activities in the stock markets. The overprotective attitude would become increasingly ap­ parent and increasingly harmful, particularly as the MoF struggled to cast off the postwar financial system.

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CONFLICT The excessive closeness between regulators and regulated meant that within the MoF, the Securities Bureau had largely become a representative of the in­ terests of the Big Four. The attitude conflicted with the overall goal of disman­ tling the postwar financial system and bringing an end to the separation between banks and securities firms. Bureaucrats knew that reform could not be forced on the securities industry, no matter how necessary. They confronted the specter of political intervention whenever they moved too fast or pushed too hard. To the extent they were unhappy, the Big Four could turn to their allies in the Diet to lobby, and interfere in, the reform efforts of the financial bureaus. Brokers and politicians seemed a natural fit. Neither was a high-status occu­ pation. Tsunao Okumura, who served as president of Nomura from 1948 until 1959, apparently had close ties to Hayato Ikeda. Prime Minister Yasuhiro Nakasone was on good terms with Koji Nakagawa, vice president of Nomura Re­ search Institute, apparently a relationship that began in their days in the Imperial Navy. Yoshihisa Tabuchi, president of Nomura at the time of the compensation scandals, was reputed to have close connections to both Nakasone and Noboru Takeshita. With these contacts, reforms sought by the MoF but opposed by the securities industry could easily find themselves topics of discussion at the high­ est levels of the LDP, an anathema to the Ministry. The securities industry and the securities markets also provided a multitude of mechanisms for transferring funds to politicians. Shares could be sold in companies just before an expected increase. Given the market power of some securities firms, a decision to promote a particular stock would cause the price to rise. Anyone who bought in advance .of the campaign would reap substantial profits. Similarly, companies about to go public could provide politicians and other influential people the opportunity to purchase shares cheaply, before the offer­ ing. Once the offering occurred, the shares would be worth substantially more. That was the essence of the Recruit Scandal that damaged the reputation of Prime Minister Takeshita, among others. In 1989, a Nomura employee was arrested for allegedly selling discounted shares to municipal workers.4 With their important political connections, securities firms had allies within the Diet who could be counted on to overcome bureaucratic resistance. The influence complicated the MoF’s efforts to reform the financial markets and cast off the postwar system of compartmentalization. The Early Battles The process of reform caused divisions within the financial industry, none more protracted than the almost continuous conflict between banks and securities firms. As the two industries squared off, the Ministry found itself the uncom­ fortable arbiter. The speed and nature of the reforms repeatedly demonstrated

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the influence of the securities industry. Time and time again the financial bureaus agreed to changes that favored brokers. The first major conflict occurred in connection with activities in the euro­ market. With banks expanding into underwriting in international markets, se­ curities firms successfully beseeched the MoF for controls and got them in the form of the Three Bureaus Agreement (sankyoku-shido). Executed between the Securities, Banking, and International Finance Bureaus in August 1974, and refined the following year, the agreement restricted the ability of Japanese banks to manage syndicates selling eurobonds. They could co-manage such issues but only if a Japanese securities firm also managed the offering and had a higher position in the syndicate. Implicitly, securities firms acting as co-managers had to receive larger allotments. Initially, the banks viewed the agreement as an annoyance, of little concern as long as only a small number of Japanese companies issued bonds in the euromarket. As the quantity of bonds increased, the restraints caused increasing irritation. Banks, therefore, began to test the boundaries of the agreement, with only marginal success. In fact, the Three Bureaus Agreement remained in place for almost 25 years. Despite some erosion, the agreement was only phased out contemporaneously with comprehensive reform of the financial system in the 1990s. The banks lost round one. They would lose others. The next battle erupted over the right to underwrite government securities. Banks were purchasing al­ most 40% of bonds sold by the government. In fiscal 1980, that amounted to ¥2.7 trillion. With no authority to sell the bonds, banks either had to hold them or sell them through their rivals, the securities firms. Financial reform, however, still required a consensus among all affected in­ dustry groups. Securities firms adamantly opposed bank entry. Led by Nomura, the largest single underwriter of government bonds, they raised the expected arguments. Securities firms were weak and the banks strong, with more time needed before the two groups could compete equally. The banks would use their corporate contacts to monopolize the business and their leverage over companies to sell bonds. In an attempt to resolve the matter in 1980, Hiroshi Yonezato, the director general of the Banking Bureau, spearheaded a compromise designed to allow banks to underwrite government debt. Labeled the “ three principles,” the “ compromise” favored securities companies. Prohibitions on the authority to sell government bonds would be removed. Authority to sell them, however, would not be automatic but would require bureaucratic approval. Moreover, the Ministry indicated that approval would not be granted in the near future. This time, however, banks registered strenuous objection to the restrictions. Unsuccessful efforts were made to resolve the dispute through meetings between the Federation of Bankers Association, an organization run by the largest com­ mercial banks, and the Banking Bureau. In a rare instance of determined op­ position, the banks went over the MoF’s head to politicians in the LDP. A direct

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confrontation with securities firms proved, however, to be a mistake. Politicians were not about to intervene at the expense of such an important constituency. The banks apparently hoped that Prime Minister Masayoshi Ohira would prove accommodating and alter the MoF’s proposal. A former MoF official, Ohira understood financial issues and banks expected a favorable hearing. His sudden death, however, dashed those expectations. The new prime minister, Zenko Suzuki, had little interest in financial matters and left matters to his finance minister, Michio Watanabe. In a face-saving gesture, a slightly altered version of the three principles found their way into the final reforms. Watanabe and Shintaro Abe, the chairman of the Policy Research Committee for the LDP, agreed to submit the issue of bond sales to a committee of three respected elders: Teiichiro Morinaga, a former vice minister and governor of the Bank of Japan, Tadashi Sasaki, the chairman of the Financial System Research Council and former governor of the central bank, and Michikazu Kono, the chairman of the Securities and Exchange Coun­ cil. The formation of the troika meant that matters would not be left entirely to risk-averse bureaucrats. Nonetheless, as the banks rightfully surmised, the sys­ tem would involve delay. They only received the power to sell the bonds in 1983. The incident did contain lessons for the bureaucracy. In pushing forward reform, politicians stood ready to support securities firms. The MoF, therefore, had little ability to implement systematic reform over industry opposition. Only when political support was neutralized would reform be possible.

Gaiatsu Once banks received the authority to underwrite government bonds, they be­ gan to agitate for additional authority in the securities markets. It was increas­ ingly clear that the barriers separating the different compartments within the financial system had become counteiproductive, including those dividing secu­ rities firms and banks. The MoF could not, however, move forward until the securities industry agreed to the reforms. The Securities Bureau had relied on Nomura to forge any necessary consensus in the securities industry over reform. As perhaps the only securities firm able to compete effectively in banking and trust activities, Nomura did not particu­ larly oppose the reform. Nonetheless, given opposition within the brokerage community, the large securities firm did not openly support the change. Efforts to set aside the now counterproductive postwar financial system seemed to be foundering on intractable industry opposition. Support for further progress, however, materialized from an unexpected source. Just as matters ap­ peared stymied, foreign banks turned the compartmentalized financial system into a bilateral trade issue. The course of events in managing foreign demands suggests a deliberate effort by some in the MoF to use international pressure to break the logjam over

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domestic financial reform. In particular, Tomomitsu Oba, the international vice minister and head of the Japanese effort, created the dynamics for reform. He suggested to the U.S. side that it involve the highest-ranking officials directly in the talks. He had close connections with Finance Minister Takeshita and Prime Minister Nakasone and used them to overcome bureaucratic resistance within the MoF. Oba also brought a strategic approach to the effort. He knew that small con­ cessions given to foreign financial institutions would reverberate back into the domestic financial markets and cause more systematic change. The result of the negotiations between the U.S. and Japan permanently fractured the compart­ mentalized financial system and made comprehensive reform a question of time. Oba used the plight of foreign banks in Japan to induce change in the do­ mestic financial markets. Foreign banks first benefited and then suffered from the compartmentalized financial system. Like all banks, they could not under­ write or engage in brokerage activities. Like all city banks they could not engage in trust activities, including asset management. They could not issue debentures, a monopoly of the long-term credit banks, and could not expand outside of the major urban centers, a monopoly of the regional and smaller banks. Foreign banks did, however, have their own monopoly. During the period when Japanese banks lacked strong credit ratings in international markets, for­ eign banks represented the only private source of dollars. They therefore earned most of their profits from medium-term unsecured dollar or “ impact” loans. The business was lucrative. In the early 1960s, the profits of Citibank, with only four branches in Japan, exceeded those of Fuji Bank, then the country’s largest. In the postwar financial system, foreign banks were the first to see their com­ partment evaporate. By the early 1970s, Japan was awash in dollars and do­ mestic banks were fully able to tap international markets. Moreover, Japanese companies could raise dollars abroad. The days of monopoly profits for foreign banks were gone. With their business in decline, foreign banks became the first category of banks to aggressively agitate for the right to invade the compartments of other financial institutions. In a way, it represented an act of desperation. They were more willing to confront the MoF over barriers in the compartmentalized bank­ ing system but only because they had little choice. Foreign banks increasingly began to lobby government officials in the United States to pressure the Japanese for reform. At the same time, they directly pressed the MoF on certain issues, forcing bureaucrats to take positions on controversial matters in an increasingly charged atmosphere. More so than with domestic banks, the MoF had to pay immediate attention. Foreign banks had an added source of influence— the U.S. government— something that could lead to controversy and political intrusion into the MoF’s area of oversight if not han­ dled properly. The growing importance of foreign pressure could perhaps be seen most clearly in connection with the efforts to obtain access to the securities industry.

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With stock market activity growing and loan business in decline, foreign banks wanted the power to buy and sell corporate securities. The authority, however, ran directly into the wall that separated the two industries. The first attempt to circumvent the restrictions came from Citibank, the most aggressive foreign bank in Japan. The parent holding company in New York, Citicorp, purchased Vickers da Costa Ltd., a British securities firm, in November 1983. Since Vickers had an office in Tokyo, the U.S. financial institution sud­ denly found itself with both a bank branch and a securities office in Japan, breaching the divide separating the two industries. The financial institution also violated an unwritten rule by failing to preclear the transactions with the MoF. The MoF could have ordered the Tokyo branch of Vickers closed. To head off that step, Citibank immediately began lobbying to retain the office. The Banking Bureau knew that efforts to close the office would cause political tur­ moil. Citibank had done everything it could to raise the profile of the purchase. The Ministry ultimately caved in, unwilling to incur the political price of closing the office. Treating the acquisition as an “ exception,” the MoF indicated that the office could remain open. Citibank’s frontal assault worked. Had the bank discussed the acquisition in advance, the Banking Bureau almost certainly would have turned thumbs down. With Citibank in, others clamored for comparable authority. The primary assault, however, came from Europe, where Japanese banks were already al­ lowed to engage in a full range of securities activities, including underwriting. Officials from the MoF met with counterparts from Germany and Britain in 1985 to resolve the controversy. The following year, the MoF agreed to give European banks securities powers but with limitations. A bank could not own more than 50% of a securities subsidiary. Ultimately, the Ministry extended the same right to U.S. banks and allowed foreign securities firms to operate banks. With Citibank having already crossed into the compartment monopolized by securities firms, the Yen/Dollar talks focussed on matters of execution. Foreign banks not only wanted access to the industry but also seats on the Tokyo Stock Exchange. After sharp negotiations, officials in the MoF agreed to work toward membership, with the first bank-sponsored securities firms admitted in 1986. Allowing foreign banks to operate securities firms represented a decisive nail in the coffin of Article 65. With the authority, foreign banks crossed barriers that had divided Japanese financial institutions since the occupation. The reforms destroyed the prevailing harmony within the financial system. Japanese banks would clamor for similar authority, something the Ministry could delay but hardly deny over the long term. The Yen/Dollar process challenged other tenets of the postwar system. Interest rate deregulation was accelerated. Restrictions on the overseas acquisition of yen were reduced. Foreign financial institutions received the right to engage in asset management, a monopoly previously left to trust banks. Almost contemporaneously with the extension of authority to foreign banks, the slow, laborious process of developing consensus on decompartmentalization

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of the financial system began. With expanded powers given to foreign financial institutions, pressure for domestic reform became unbearable. In the aftermath of the negotiations, the postwar financial system was finished, although it would take another seven years before the eulogy could be read.

THE WALLS COME TUMBLING DOWN (FINALLY) Brokers Versus Banks The MoF continued to push forward comprehensive reform of the financial system. Moreover, the endgame was underway. Japanese banks already had the power to underwrite government securities and foreign banks had the power to operate securities firms. Elimination of the wall separating banking and securi­ ties activities was, therefore, inevitable. Nonetheless, the process still required a consensus and the securities industry continued to vehemently oppose the reform. Delay was becoming dangerous. In the first quarter of 1990, the bottom fell out of the stock market. Share prices dropped over 25% and would continue to tumble until the Nikkei average had fallen by 60%. Volume declined and the profits at the securities firms fell into the red. Nor were the biggest firms spared. Nomura saw profits almost disappear while the other members of the Big Four lost money, with Yamaichi incurring its largest losses since its near failure in 1965. Smaller firms were in even more serious trouble. Until the early 1990s, the Ministry had counted on the cooperation of the Big Four. They, particularly Nomura, could be expected to step in and handle any crisis, including, if need be, the absorption of an ailing firm. While the Big Four got away with questionable practices in the market, they served a critical gov­ ernment function by ensuring stability in the securities markets. Relying on other financial institutions, particularly city banks, to bail out ailing brokers, ran headlong into the compartmentalized financial system. Article 65 continued to separate banks and securities firms. As long as that barrier remained in place, the MoF was powerless to force city banks to step in. Despite the growing need for decompartmentalization, the securities industry resisted. In 1988, the Banking Bureau, then headed by Sadaaki Hirasawa, de­ vised a plan to permit banks and securities firms to invade each other’s territories through the formation of investment banks. Before the bureau could obtain a consensus on the matter, however, details leaked to the public. When opposition by securities companies mounted, the plan was abandoned. Next were the dueling councils, each representing their industry and each controlled by a different bureau within the MoF. In 1989, the Financial Systems Research Council, an arm of the Banking Bureau, recommended that the com­ partmentalized system be ended, with banks allowed to engage in securities and trust activities through a separate subsidiary. Not to be outdone, the Securities and Exchange Council, the comparable body

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for the Securities Bureau, issued a report agreeing with some of the recommen­ dations but calling for restrictions on the flow of funds, personnel and infor­ mation between the bank and any newly formed securities subsidiary. Arguing for delay, the report concluded that banks should be prohibited from engaging in securities activities until various issues had been resolved. Despite the disharmony evidenced by the reports, a consensus was emerging within the MoF, something that would be publicly reflected in a report of the Financial Systems Research Council in 1991. Officials in the Banking Bureau had made the rounds and discussed the matter with international regulators, including those in the United States and Britain. The barriers would come down and compartmentalization ended, although not through universal banks but through separate subsidiaries. The Role of Scandal Despite the consensus within the MoF over the shape of reform, bureaucrats were unable to complete the process over the protracted opposition of the se­ curities industry. Not until scandal engulfed the industry and neutralized the political power of the Big Four were the reforms finally adopted. That occurred in 1991. The compensation scandals arose out of promises given by securities companies to large clients concerning their investment re­ turns. If the returns did not meet expectations, brokers would pay the shortfall. The practice of protecting large clients from the turmoil of the market ultimately became public, engulfing the industry in a raft of recrimination and criticism. The compensation scandal almost certainly began as a deliberate effort by tax authorities within the MoF to reduce the influence of the Big Four, particularly Nomura.5 Proof was in the source of the .scandal. The information had come from the MoF, specifically the more independent National Tax Administration Agency.6 With the securities industry humbled, the Banking and Securities Bureaus could use the opportunity to bring closure to the interminable process of finan­ cial reform. Unexpectedly, however, the scandal amounted to a Pandora’s box that, once opened, could not be quickly closed. In the end, it was the MoF rather than industry that suffered most. Isolated scandals within the financial system had arisen from time to time, but they tended to be firm-specific, not necessarily indicative of systematic prob­ lems, and easy to contain. The compensation scandals were qualitatively differ­ ent. The scandal affected the entire industry. The scandal involved corporate accounts set up at trust banks but handled by securities firms. To gain business, brokers had promised positive returns, al­ though not necessarily specifying a particular amount. They did so never ex­ pecting to have to honor the promises. The market was going up, not down, and expected levels of return tended to be met. Payment was necessary only in aberrational cases. Only with the collapse of the stock market in 1990, however,

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the risks associated with the promises became clear. Securities companies sud­ denly found themselves receiving requests for repayments and having to pay them to maintain client relationships. In an effort to at least mitigate the expenses, securities firms, led by Nomura, sought to treat some of the losses as deductible entertainment expenses. When tax authorities threatened to disallow the deductions, the securities companies hinted at a possible political appeal. The disregard for the MoF’s authority grated more than usual. Not long afterwards, the information leaked to the public, unleashing the scandal. At first, things proceeded much to the MoF’s advantage. Securities firms came under withering criticism. The guarantees demonstrated that the brunt of the falling stock market fell on small investors who had no comparable ability to obtain compensation. With growing public condemnation, the political allies built up by the Big Four were suddenly in short supply. Prime Minister Kaifu, brought to office as a reformer, was more interested in appearing stern towards the errant companies than in helping them. The Diet quickly passed legislation outlawing the guarantees. The Securities Bureau, the ally of industry, reacted to the scandal harshly. Given the “ loss of investor confidence” as a result of the practices, the bureau required offending securities firms to temporarily close their corporate sales divisions, assessed penalties, and induced resignations of top officers at Nomura and other firms. Each securities firm was expected to take internal steps to prevent repetition. Nikko, for example, required all board members to forfeit bonuses and resign from publicly held positions and imposed salary reductions on 12 persons. Two employees were forced to quit, two were demoted and one was “ severely warned.” In addition, Nikko conducted an internal investigation and disclosed the results to the MoF. The Endgame With securities firms humbled and in no position to appeal to their patrons in the Diet, the Ministry had a momentary opportunity to transform the proposals for decompartmentalization into law, with the Diet adopting the appropriate legislation in 1992. The legislation finally removed the barriers separating most categories of financial institutions. Commercial banks, trust banks, and securities firms could each now enter the other’s territory. The legislation did not completely decompartmentalize the financial system. Barriers still existed on entry into the insurance industry. In addition, long-term credit banks retained their monopoly over debenture-issuing authority. Broker­ age commissions were not deregulated. The timing of complete decom­ partmentalization was not specified. Still, for all intents and purposes, enough of the barriers had been eliminated to acknowledge that Japan had cast off its postwar financial system. Nonetheless, reform, while inevitable, would be deliberate, carefully managed

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by the MoF. Aware that dramatic reforms could impact particular classes of financial institutions, the MoF imposed substantial limits on the new authority. Securities subsidiaries for banks were permitted, but with limits on their au­ thority and delays in their formation. The first city banks only received approval to form their own securities subsidiaries in 1994. Moreover, the subsidiaries had limited authority, with the MoF prohibiting them from underwriting equity se­ curities and from engaging in brokerage activities. The deliberate pace provided the MoF with leverage, temporarily enhancing bureaucratic authority. By acquiring a sick securities company, a bank could engage in a full range of securities activities, including services as a broker. This was the inducement given to Daiwa to acquire Cosmos, a securities com­ pany done in by the compensation scandal. In return for the rescue, Daiwa received full securities powers. As the only city bank with asset management authority, Daiwa became the first universal bank in Japan. In the long term, however, the reform could only bring about a diminution of bureaucratic authority. As financial institutions obtained full authority to op­ erate in the securities and asset management areas, a class of superbanks would emerge. They would be much less beholden to officials in the MoF and much less inclined to follow bureaucratic guidance. THE FALL FROM GRACE The MoF had succeeded in doing something remarkable. After more than a decade of effort, the compartmentalized financial system was finished. A few vestiges remained. Long-term credit banks still had their monopoly, although that was coming to an end as the merger between the Bank of Tokyo and Mitsubishi illustrated. Brokerage commissions were still not deregulated, al­ though the first tentative steps had been taken. Instead of basking in success, however, the MoF found itself criticized and scorned. Indeed, rather than receive credit, the MoF had to marshal its resources to prevent dismemberment. The explanation was the MoF’s insistence on using postwar practices in a largely transformed financial system. Blame When the compensation scandal broke, the industry was humbled; its political allies gone. Legislation sought by the powerful finance ministry could now be submitted to the Diet and passed. The scandal, however, rapidly turned against the bureaucrats. The Ministry’s criticism of the securities industry engendered an unexpected response. Nomura’s president, Yoshihisa Tabuchi, who was forced out of office to atone for the scandal, stated publicly at a meeting of shareholders that the compen­ sation payments were made “ in consultation with the Ministry of Finance.” After Tabuchi resigned, the new president, Hideo Sakamaki, promptly apolo­

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gized for the remarks, but the damage was done. The MoF was directly impli­ cated, violating the unwritten code. The Securities Bureau did not expressly authorize the continued use of guar­ antees. Indeed, officials in the Securities Bureau issued an administrative order in 1989 prohibiting the practice. Otherwise, however, they took no specific steps to ensure that the guarantees had ceased. As the stock market started to collapse, the bureau lost the incentive to insist upon compliance. Strict enforcement would have caused clients to close accounts and sell shares, further weakening an already depressed stock market. The approach was a traditional bureaucratic response to controversy. Bureau­ crats often knew about but overlooked questionable practices. Officials almost never expressly approved them but simply failed to object. This form of wink and nod allowed the MoF to distance itself when things went wrong. Moreover, rotating every few years, MoF officials could adopt a strategy of delay and indecision, hoping that they would move to a new position before any problem surfaced. This time the approach did not work. Tabuchi’s outburst directly implicated the Securities Bureau. Moreover, with individual investors suffering from the fall in the stock market, the MoF’s awareness of, and the failure to stop, the unfair practice was enough to justify sharp criticism. Nor did the Securities Bureau help itself in the handling of the scandal. The bureau refused to disclose a list of the companies receiving compensation, with the information becoming public only when leaked to the Nihon Keizai Shimbun. The inopportune use of secrecy suggested a conspiracy between the MoF and industry. The scandal also focused attention on the practice of amakudari. The secu­ rities industry had become overpopulated with retired ministry officials. In par­ ticular, the most influential “ Old Boys” resided there. Known by their initials, NTT, they included Minoru Nagaoka, president of the Tokyo Stock Exchange, Hiroshi Tanimura, chairman of the Capital Markets Promotion Foundation, and Michio Takeuchi, chairman of the Capital Market Research Institute. All three had at one time been administrative vice ministers in the MoF and presidents of the TSE. The “ Old Boys” were consulted on important promotions and amakudari positions. They therefore had continuing ability to influence careers in the MoF. Officials in the bureaucracy knew this and accorded the Old Boys considerable deference. The perception existed that these former officials tended to use their influence with the Ministry to protect the industry that now employed them. Even Ministry bureaucrats inclined to take a more aggressive stance had to risk the potential displeasure of these retired officials, with possible adverse conse­ quences to their careers. Punishment and Retribution The scandal had a number of important ramifications. Unprecedented public pressure forced the resignation of the Minister of Finance, Ryutaro Hashimoto.

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A powerful politician and future prime minister, Hashimoto had his career dam­ aged by MoF mismanagement. Equally unusual was the mea culpa by the Min­ istry itself. Recognizing its implicit participation, top officials took a 10% pay cut. Both Hiroshi Yasuda, the vice minister, and Nobuhiko Matsuno, the director general of the Securities Bureau, suffered the humiliating fate. The scandal also illustrated the impact of bad timing on a career within the MoF. Matsuno had the misfortune to be serving as director general when the scandal broke. A member of the class of 1961, Matsuno had spent time in a number of important positions within the Banking Bureau, including director of the commercial bank and coordination divisions and deputy director general. He also, however, had experience in the Securities Bureau. In 1983, he became inspector of the TSE, a post that gave him considerable exposure to the head of the exchange, Takeuchi, one of the “ Old Boys.” In 1990, he was elevated to director general of the Securities Bureau. Matsuno had every reason to believe that if matters worked out, he would receive another high-ranking post, probably director general of the Banking Bureau. A strong advocate of ending the separation of securities firms and banks, Matsuno was viewed as someone who could resolve the dispute. He was promoted to director general early, before any other member of his class. Matsuno was therefore elevated at a sensitive time to a sensitive position and was viewed favorably by his superiors. He was, however, in the wrong place at the wrong time. When the scandal broke, his career in the MoF was effectively over, despite a lack of complicity in the problem. At the next rotation, Matsuno was ousted, with Tadashi Ogawa, a fast-track career official with experience in both the Budget and Tax Bureaus, taking over. The appointment was indicative. Ogawa had no experience in the Securities Bureau; his expertise was in tax. On his way to becoming administrative vice minister, Ogawa’s appointment was a sign that the MoF wanted someone with authority who was not close to the securities industry. In addition to replacing Matsuno, every person in a critical position in the bureau was replaced. This included the chiefs of the Coordination, Capital Market and Corporation Finance divisions. Neither the pay cuts nor the resignation of Hashimoto nor housecleaning within the bureau quelled the public furor over the MoF’s role in the scandal. Ultimately, the entire institution had to pay a price for complicity. The result was the first significant reorganization of the MoF since 1964. Although partly intended to deal with the appearance of excessive closeness between the Securities Bureau and the financial industry, the reorganization mostly amounted to punishment for complicity in the compensation scandals. Early proposals supported by some politicians called for a dismemberment of the Ministry, with its budget and financial market functions separated. The pro­ posals, however, never had much of a chance. Instead, the Ministry had to accept a humiliating reorganization. Inspection responsibilities over securities firms and stock exchanges were

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stripped from the Securities Bureau and placed in a more independent Securities and Exchange Surveillance Commission (SESC). Inspection authority over banks and other financial institutions was removed from the Banking and Inter­ national Finance Bureaus, with a new Financial Inspection Section created in the Secretariat. Having been responsible for the scandal, the Securities Bureau suffered one more blow. In addition to the loss of the Inspection Division, the Bureau was required to combine the primary and secondary trading divisions into a single division. As a result, the Bureau lost two divisions, falling from six to four, a serious bureaucratic loss. Fewer high-ranking positions would now exist in the bureau, further reducing its internal influence and attractiveness to career per­ sonnel.

LESSONS LEARNED The Securities Bureau and securities industry had become too close. The problem of excessive closeness represented an inherent risk in any system based significantly on personal relationships and an absence of bureaucratic expertise. Nor was the problem limited to the Securities Bureau. It would surface again when officials in the Budget Bureau were found to have accepted favors from real estate speculators. In some respects, the compensation scandals represented an extreme. Ordi­ narily, the MoF had sufficient leverage over industry at least to create the ap­ pearance of supreme authority. In the securities area, however, that was not the case. The lack of expertise and low status of the Securities Bureau and the overwhelming domination of Nomura created an unusual dynamic. The bureau was beholden to industry, not the other way around. In other cases where the influence of industry was perceived to be too strong, the MoF had taken steps to alter the situation. In the 1960s, the Banking Bureau had become too close to the financial industry and someone was needed who had new ideas and was less beholden to industry. Satoshi Sumita was sent to run the bureau, even though he had no experience in the area. The same need to lessen industry’s hold over the Securities Bureau was never fully perceived. Moreover, even had it been, reducing industry influence would not have been easy. For one thing, the securities industry contained the “ Old Boys,” retired but still influential vice ministers perched in influential positions. Bureaucrats wanting to continue to rise in the Ministry had considerable incen­ tive not to make these “ Old Boys” unhappy. Engaging in policies antagonistic towards the industry employing these officials might engender a negative re­ action and interfere with bureaucratic promotions or lucrative amakudari posi­ tions. For another, the Securities Bureau was particularly dependent upon the Big Four for expertise and policy implementation. Bureaucrats and industry partic­

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ipants could not, therefore, be separated without fundamental internal changes within the bureau. The housecleaning of all “ tainted” officials was not enough. Despite the humiliation of the reorganization, however, the MoF as a whole benefited from changes in the securities oversight function, even if the process was painful. The entire Ministry had suffered because of the excessive closeness of a single bureau to the industry it regulated. The reorganization did not result in any loss of authority for the MoF but did create additional, more independent bureaucratic channels for information about the activities of the securities in­ dustry. The Securities Bureau had lost its regulatory monopoly over the secu­ rities markets, and now had to negotiate with officials in the SESC concerning developments in the industry. The hostility generated by the scandal notwithstanding, the Securities Bureau and securities industry had little choice but to reconcile. While relations with the securities industry had turned frosty and informal communications reduced, both groups had a much too symbiotic relationship for matters to stay that way. The securities industry, particularly Nomura, knew that hostile relations with the bureaucracy would work increasingly to its detriment. The MoF still con­ trolled entry into the industry. With financial reform a reality, an aroused Min­ istry might allow banks to expand quickly into the securities business. An angry regulator could also schedule for reform the hallowed system of fixed commis­ sions. Bureaucrats also continued to need securities firms. Until the bureau gained expertise, it would be dependent upon the securities industry. The relationship would only change permanently when bureaucratic practices evolved, obtaining additional sources of information and developing internal expertise. This would require changes in the system of rapid rotation and improvement of the Bureau’s status, attracting the best the MoF had to. offer. The most significant problem illustrated by the scandal, however, was the least discussed. It demonstrated unequivocally the bureaucratic unwillingness to take risks and act decisively. Officials in the Securities Bureau knew about the guarantees and had done little to stop the practice. The inaction demonstrated a refusal to grapple with controversy and a bureaucratic willingness to opt for delay. As long as officials were not affirmatively confronted with actual evidence of illegal payments, they could avoid the issue and ultimately place the blame on industry if anything surfaced. That would have occurred in the case of the compensation scandals had not Tabuchi and Nomura implicated the Securities Bureau directly. Not limited to the securities industry, the avoidance of responsibility would later plague the Banking Bureau. This would occur with the scandal surrounding the $1.1 billion in trading losses incurred by Daiwa Bank. Ministry officials would discover once again that the failure to take forthright steps to resolve a contentious matter would redound to the bureaucracy’s detriment. In deciding to reform the financial system, therefore, the MoF did not turn

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the same degree of introspection and analysis on itself. In the same way that the financial system had become dated and counterproductive, so had a number of bureaucratic practices. The MoF likewise represented a postwar fixture that required reform.

CHAPTER 7

Bailout: The Banking B ureau an d th e Banking Industry

Compartmentalization was not the only vestige of the postwar system that had to change. The Ministry of Finance would also be forced to reconsider its tra­ ditional emphasis on stability. In the financial system, the two most obvious manifestations were the convoy system, which involved the protection of the weakest banks, and the absolute that no bank could fail. The two were related; both sought to prevent any destabilizing collapse. The policy against failures had its roots in the financial panics of the 1920s. With financial institutions in trouble, depositors rushed to withdraw savings, causing bank failures and putting the entire system at risk. The government implemented a rescue plan but the damage to the bureaucratic psyche was im­ mense. These types of failures were to be avoided at all costs. The prohibition on bank failures, however, developed a life of its own, un­ moored from its historical roots. Although some legitimate concern existed over the health of the financial system in the early years after the occupation, they receded as the economy recovered. The changed circumstances made no differ­ ence to those in the Banking Bureau. The policy of no failures remained per­ manently entrenched in the bureaucratic psyche. Bureaucrats in the Ministry came to believe either that they had the capacity to prevent any failure or that they could control the “ moral hazards” that often led to a failure. They were wrong on both counts. Moreover, attachment to the absolute had costs. It meant that the Banking Bureau had little experience and was not adequately prepared when the inevitable failures occurred. The piercing of the bubble economy in the 1980s and the prolonged slowdown that followed doomed the proscription on bank failures. Financial reform also contributed. Sheltered, many banks proved incapable of making the transition

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to a market economy. Whole classes of financial institutions were simultane­ ously at risk. In dealing with the crisis environment, the bureau relied on two traditional and questionable approaches. The first was to mask the extent of the problem, ostensibly to avoid a panic. With commercial banks wallowing in bad loans, the bureau tolerated efforts to obscure the true extent of the problem. Completely accurate numbers, so the theory went, might cause a loss of faith in the financial system. In fact, the lack of transparency only made matters worse. The Banking Bu­ reau’s repeated efforts to build confidence by suggesting that the worst was over simply were not believed. Moreover, unable to differentiate among the banks, international lending markets imposed a Japan premium on all financial insti­ tutions. Japanese banks had to pay more to borrow, whether healthy or un­ healthy. The second questionable and related approach was the bureau’s constant at­ tempt to play for time. If the economy and, more specifically, the real estate market recovered quickly enough, the problem would largely correct itself. For the first half of the 1990s, therefore, denial reigned. Given the hope that the economy would save the day, bureaucrats obscured the extent of the problem and refused to confront directly the deteriorating financial condition of whole classes of banks. Forbearance substituted for decisiveness. Efforts to prevent failures were, however, overtaken by events. The economic slowdown continued longer than expected. Banks became insolvent. Initially, efforts were made to handle matters as usual: through secrecy and backroom negotiations. In the transformed economy, however, this approach no longer worked. As banks collapsed and the public lost confidence, the bureau learned. Panics could be avoided so long as the government reacted quickly and decisively. Particularly after Yoshimasa Nishimura became director general of the bureau, banks were put on notice that the traditional policies could not continue. Ac­ curate reporting became an imperative; rapid seizure and closure of unhealthy financial institutions became more common. The lesson was a hard one and the learning process ugly. Bureaucrats had a tough time accepting that they could not control events or dictate outcomes. As the decade progressed, the MoF’s missteps and mistakes were glaringly and publicly apparent. The Banking Bureau’s approach to regulation, however, evolved. The Bureau became more decisive, coddled industry less and, despite the bad press, grew in effectiveness. THE EXEGESIS The bureaucratic prohibition on bank failures arose out of fear of financial instability. The concern had historical roots. Laws governing commercial bank­ ing were put in place with the adoption of the Bank Act in 1890. Designed to

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promote expansion, the law contained no capital or reserve requirements, re­ strictions on non-banking activities, or loan limits. Deposit insurance did not exist. The result was predictable: rapid growth of rickety financial institutions.1 By the 1920s, the Japanese banking system amounted to two different ones existing side by side. Large numbers of weak, barely solvent banks coexisted with a small number of large, powerful banks, with the zaibatsu banks the principal examples. The financial system also had a group of government banks that lent primarily to specified segments of the economy.2 The system was over-banked and unstable. The inevitable financial panic fi­ nally occurred in 1927. It began with the collapse of the Bank of Taiwan, a supposedly well run, safe institution. The bank had lent considerable sums to Suzuki & Co., the newest industrial group. With Suzuki tottering, a number of Japanese banks called in short-term loans to the Bank of Taiwan. Unable to repay the loans, the bank turned to the Bank of Japan for help. When the funds were not forthcoming, the bank went under. The result was panic. As one gov­ ernment report bloodlessly put it: “ This caused great alarm and resulted in runs on banks throughout the whole country.” 3 With no system of deposit insurance, any challenge to the integrity of the financial sector sparked panic. This was no exception. Depositors began to with­ draw funds, threatening to cause a waive of insolvencies. The Bank of Japan finally had to pump money into the system to ensure liquidity, but the need for more systematic reform was clear. The government responded by adopting the Banking Law of 1927, substantially tightening regulatory requirements for fi­ nancial institutions. The Banking Law remained in place, without significant change, until 1981. The longevity had one major explanation: ambiguity. The law contained little more than an outline, providing the MoF with considerable discretion. With little or no regulatory augmentation, the MoF was able to use the law to totally reshape the financial system. The panic taught financial regulators a handful of hard lessons. The first was that a single large failure could destabilize the entire financial system. The sec­ ond was that government rescue efforts needed to occur quickly, before panic could spread. There would be no more failures like that of the Bank of Taiwan. These lessons were applied with vigor when Yamaichi, the second-largest se­ curities firm, almost collapsed in 1965. The crisis also brought home the need to increase regulatory oversight. The Ministry created a Banking Bureau, with responsibility for supervising the fi­ nancial markets. The bureau had an immediate task: to bring stability to the banking system. Consolidation was to be the main method. With the goal of returning confidence to the financial system, the Banking Bureau embarked on a policy designed to shrink the number of commercial banks through “ amalgamations.” A recurring theme, the approach would be a fixture of the bureau’s regulatory philosophy. Only at the insistence of occu­

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pation officials in the 1940s did efforts to encourage consolidation temporarily abate. The primary target of consolidation had originally been lower-end, less sol­ vent financial institutions. To encourage banks to combine, the bureau imposed stiff capital requirements. Over half of the existing banks did not meet the new standards, requiring them to either find the necessary capital, merge or liquidate. As Japan went on a war footing, however, the purpose of consolidation changed. No longer motivated by prudential concerns, consolidation became a mechanism for controlling capital and financing war-related industries. Larger banks, therefore, did not escape the trend. Sanwa, a name meaning “ three harmonies,” formed in 1933 as an amalgamation of three Osaka banks, Thirty-Fourth, Yamaguchi and Konoike. Bank of Kobe was formed in 1936 from a merger of seven banks in Hyogo Prefecture; Saitama in 1943 from the four largest banks in Saitama Prefecture. The Banking Bureau also pushed for consolidations outside of the urban centers under the slogan of “ One Prefecture, One Bank.” Predictably, the number of commercial banks fell dramatically, from 683 in 1931 to 377 in 1937 to 61 in 1945. The steep decline in the numbers did not fully indicate the level of concentration. Five entities dominated the banking sector. The four zaibatsu banks, Teikoku (a combined Mitsui and Dai-Ichi), Yasuda (Fuji), Mitsubishi and Sumitomo, had the lion’s share of the banking business. By 1944, they accounted for 74.9% of all bank loans. Sanwa repre­ sented the only large non-zaibatsu bank to survive. The trend ended temporarily during the occupation. Allied officials wanted to reverse the concentrated banking system by introducing additional competition. Some argued forcefully for a breakup of the large banks. After a protracted and sharp internal dispute within SCAP, the approach was rejected as potentially too destabilizing and replaced by a policy of creating additional financial institu­ tions. Simply creating additional competitors, however, was not enough. Most were unlikely to survive in a competitive environment. Trust companies and securities firms in particular emerged from the war largely insolvent, with no immediate prospects for a return to health. Asset management in a war-tom, poor country had little immediate potential, particularly with the stock market closed for most of the occupation. The concern was that the large commercial banks would absorb the fledgling institutions. As a result, a series of occupation-imposed walls were put in place in an effort to ensure their continued independence. The compartmentalized system temporarily put an end to the Banking Bureau’s efforts at consolidation. Occupation policies actually increased the number of financial institutions. Moreover, by building walls separating various classes, the compartmentalized system ensured the survival of these new banks, preventing their absorption by the large city banks.

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CONTROL AND CONSOLIDATION With the end of the occupation, the Banking Bureau was content with the task of managing the compartmentalized system, preferring to round it out rather than significantly alter its shape. In fact, early policies strengthened the walls between the different classes of financial institutions. The separation of trust and commercial banking was completed in the early 1960s when all remaining com­ mercial banks except Daiwa were forced to divest their trust departments. By the mid-1960s, however, consolidation again became the controlling phi­ losophy. The resurrected approach had several explanations. First, the personal style of oversight would be easier to implement if fewer participants existed. Consolidation would reduce the number of financial institutions that had to in­ teract with the Banking Bureau. Second, the most likely source of instability in the financial system tended to emanate from smaller, less well run banks. Consolidation amounted to a type of preemptive strike. Larger, better-capitalized banks with more skilled man­ agement would absorb the smaller financial institutions before any financial crisis occurred. The sector would have a smaller number of larger (viewed as synonymous with healthier) financial institutions. Third, merged banks tended to be good candidates for amakudari. Having to reconfigure operations and branch networks following a merger, they were in particular need of various regulatory approvals. Merged banks, therefore, were more disposed to accept retiring Ministry officials as a means of improving access to regulators. These goals could be achieved by deliberately shrinking the number of finan­ cial institutions through increased consolidation. As part of the effort, the Bank­ ing Bureau restricted the entry of new competitors. Other than an occasional, marginal foreign bank, the bureau issued no new licenses to banks after the one given to the last long-term credit bank in 1957 and the last trust bank in 1962. Any merger or consolidation, therefore, would cause an absolute decline in the number of banks. Kakuei Tanaka, during his tenure as finance minister in the 1960s, gave the first public indication of the return to the prewar policy of consolidation. Not much followed the pronouncements.4 Only when Satoshi Sumita became direc­ tor general of the Banking Bureau did the MoF begin to throw its weight behind consolidation. A follower of Fukuda and later elevated to governor of the Bank of Japan, Sumita spent most of his career in the powerful Budget Bureau. He had no real banking experience but was placed at the head of the bureau because of the perception within the MoF that a new perspective on regulation, untainted by excessively close relations to industry, was needed. In early 1967, Sumita, as director general of the Banking Bureau, publicly called for a “ major overhauling” of the financial system. Among other things, he wanted to encourage further consolidation. To implement the approach, he

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engineered legislative reform that permitted banks in different categories to merge with each other. In addition, the bureau ceased requiring merged banks to close overlapping branches. The reform effort illustrated the MoF’s vision of the consolidation process. The Banking Bureau wanted the number of commercial banks to shrink, without significantly altering the compartmentalized financial system. The expectation, therefore, was that the large financial institutions would absorb the smaller ones. The shape of the financial institutions would remain; only the number of par­ ticipants would change. Despite all of Sumita’s efforts, however, the process of encouraging mergers proved surprisingly difficult. Opposition arose from a wide array of sources. In the case of a smaller bank, management knew that it would have a weaker position in the larger entity, with few opportunities for promotions. Customers dependent upon a particular bank for capital had concerns that a merger of unequals might result in diversion of funding to the larger bank’s clients, a genuine concern during an era of capital shortages. As a result, smaller banks were most often open to mergers only when they had no choice. That typically meant failing financial health. Larger financial institutions were generally willing to acquire the sick banks to obtain their net­ work of branches, something still in short supply given the MoF’s penurious attitude toward new offices. As for the largest financial institutions, few were interested in mergers in which they would be completely subsumed by the acquiring bank, something that happened to Dai-Ichi when it merged with Mitsui during the war to form Teikoku. Mergers of equals represented the only viable possibility. Nonetheless, even they had disadvantages. They had to ensure fair treatment of both banks and their constituencies, including employees, clients and the community. To ensure proper treatment, few branches could be closed, few tasks rationalized, few promotion opportunities eliminated. The usual benefits of a merger— greater efficiency, cost savings, and so on— rarely occurred. The mergers had only one significant advantage: influence. Regulatory ad­ vantages in Japan went to the largest banks. They gained greater access to the top echelons of the Banking Bureau. The largest banks could open more branches abroad and engage in more innovative practices. In an era of compartmentalization and tight control of branches, banks had almost no likelihood of elevating their rankings through ordinary growth in business. Mergers rep­ resented the only available method. The problems with, and limitations on, mergers were illustrated by Dai-Ichi’s search for a partner. The initial betrothal was to be with Mitsubishi, a former zaibatsu bank. In January 1968, the two banks announced a merger. The com­ bination received strong support from the Banking Bureau, with Sumita, the director general, having a hand in encouraging the transaction. He was partic­ ularly interested in seeing his program of consolidation implemented. The merger, however, generated a deluge of criticism. No matter how the

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merger was packaged for public consumption, the probability that Mitsubishi, the zaibatsu bank, would dominate the combination was overwhelming. With capital still in short supply, customers of Dai-Ichi complained that the arrange­ ment would lead to favored treatment for Mitsubishi clients. Employees also felt that the acquisition would work to their disadvantage. With all the grum­ blings, some of the more senior directors at Dai-Ichi spoke out against the transaction. The collective opposition ultimately doomed the acquisition. The aborted merger showed the limits on the Banking Bureau’s influence. The MoF had clearly favored and pushed for the merger, with Sumita staking considerable credibility on the combination. The collapse essentially amounted to a regulatory black eye. Blaming events on personal factors, Sumita told re­ porters that the transaction did not succeeded because of an “ obstinate old man,” a reference to Kaoru Inoue, the chairman of Dai-Ichi, who opposed the combination. Dai-Ichi did not wait long before trying again and returning to the MoF’s good graces. A year later, the bank announced a merger with Nippon Kangyo Bank. While the merger promoted the Banking Bureau’s policy of amalgama­ tions, the MoF had little to do with it. Bureaucrats were kept in the dark until after the presidents of the two banks agreed on the transaction. Those involved in the negotiating process knew that informing the MoF could result in leaks as bureaucrats tried to test industry reaction. They therefore kept them out of the loop until an agreement had been reached. The merger also showed the consequences of the bureau’s policy of promoting amalgamations. The combination reduced the number of financial institutions, a clear bureaucratic goal. The merger, however, produced a lumbering leviathan rather than a lithe competitor. Separate vestiges of the two banks remained for two decades. Redundant branches were .not closed, operations not rationalized. Only in the 1990s was the Nippon Kangyo personnel office finally closed and the practice of alternating top officials between the two banks ended. Dai-Ichi was surpassed by more aggressive and nimble competitors, particularly in over­ seas expansion. Overall, the goal of amalgamations was not much of a success. The Banking Bureau could not simply will an increase in mergers. Moreover, even where the bureau succeeded, it was hard to say that the Japanese financial markets were any better off. Indeed, as banks got larger through mergers, they raised the ante. The number of banks fell but with the size of the survivors increasing, any failure would cause reverberations throughout the financial system. MANAGING INSOLVENCIES Despite the considerable energy of the Banking Bureau, the process of con­ solidation proceeded slowly. Healthy banks had little interest in being absorbed.5 Mergers were therefore infrequent and involved smaller financial institutions, often with management problems.

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In those cases, management had no choice. Confronting a possible shutdown, a merger was the only viable option. Moreover, while the absorbed bank would often face ignominious treatment at the hands of the acquirer— there was gen­ erally no effort to accede to the sensitivities of the failing bank— it was still a better fate than bankruptcy and liquidation. Failure in Japan was more than a serious matter; it represented a form of corporate death. With lifetime employment and little lateral movement among banks, employees of a failed financial institution could not simply move to another comparable position. Failure, therefore, meant a permanent end to the professional careers of most employees. Officers of a failing bank wanted to avoid this consequence; so did the Banking Bureau. In those circumstances, the attitude of the bureau was to avoid failure at all costs. Moreover, regulators had other concerns besides employees. Until 1971, the country had no system for deposit insurance. Depositors in a failed bank would have lost their funds. Rumors of bank insolvencies could generate desta­ bilizing runs. Banks, therefore, were not allowed to fail. Instead, if on the verge of failure, the Banking Bureau engineered a rescue operation. A rescue meant absoiption by another larger and healthier financial institution, bad loans and all. The healthy bank would acquire all of the assets, employees and offices of the failing financial institutions. The approach avoided the closing of offices, the dismissal of employees, or losses to depositors. Rescues involved considerable behind-the-scenes maneuvering by the MoF. The Banking Bureau viewed itself as the mastermind, keeping information secret until a solution had been devised. The extent of the failing bank’s financial problems was never revealed. Leaving the public in the dark became a regular part of the process. The furtive approach notwithstanding, the process created a sense of stability and confidence. Absorption of sick financial institutions by healthier banks did not occur out of altruism. They benefited from the acquisitions. The most common motivation for a merger was expansion of a bank’s branch network. The Banking Bureau was responsible both for issuing branch licenses and engineering the rescue operations. The bureau historically had taken a parsimonious approach toward approving new branch offices for city banks. With banks eager for additional offices to attract retail deposits, acquiring a sick bank effectively circumvented the restrictions. That explained the acquisition of Heiwa Sogo, the sixth-largest mutual or sogo bank, by Sumitomo in 1986. Heiwa had been riveted by internal strife after the death of its founder, Eizo Komiyama, in 1979. It also found itself with a raft of nonperforming loans. The Ministry engineered a bailout of Heiwa Sogo with Sumitomo acting as white knight. An Osaka-based bank, Sumitomo was attracted to Heiwa’s 103 Tokyo branches. In addition, the bailout promised an additional, important advantage. Sumitomo could keep the longer operating hours of the smaller bank. Unlike

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city banks that closed their branches at 3:00 p .m ., sogo banks had been allowed to operate until 7:00 p .m . In return for these advantages, Sumitomo was willing to absorb Heiwa’s huge losses, ultimately costing the city bank in the neighborhood of ¥200 billion. It took two years to work through and collect the recoverable loans. The acqui­ sition, however, gave Sumitomo access to the Tokyo market and enabled it to climb to the top of the rankings in Japan. For much of the postwar period, intervention by the Banking Bureau worked. From 1955 through 1994, about 280 mergers occurred, primarily involving small sogo banks, credit cooperatives and credit associations. Most if not all were bailouts engineered by the bureau or the Bank of Japan. In sharp contrast to the U.S., where thousands of banks had collapsed, Ministry officials could proudly state that no bank had failed in Japan during the postwar era. Nonetheless, the success needed to be put into perspective. The Banking Bu­ reau had not confronted the insolvency of a large bank. The near collapse of Yamaichi in 1965, then the country’s second-largest securities firm, provided the only experience with a large-scale collapse. The rescue was novel, ad hoc, and unlikely to provide a blueprint for subsequent failures. Moreover, the failure of smaller banks had taken place on an isolated and infrequent basis, with a putative purchaser usually easy to identify. In those circumstances, the bureau could maintain secrecy and generally take its time developing an appropriate rescue operation. The bureau developed little expe­ rience with multiple failures and no experience with healthier financial institu­ tions refusing to pay the costs of an acquisition. The bureau’s historical emphasis on consolidation had other consequences. By not letting in new competitors and inducing combinations, even small banks grew large. Increasingly, no bank was too small to fail without causing problems throughout the financial system. The Banking Bureau found itself in a hopeless position that it had created— even small banks could not be allowed to fail, yet their size meant greater indigestion for the financial system in the event of a rescue attempt. The process of consolidation also depended upon the cooperation of the larger banks and their willingness to absorb failing banks. As the branch networks of failing banks became less appealing— an inevitable consequence of reform— and the financial problems more severe, resistance to these bailouts would mount. SOFT LANDING AND CRISIS AVOIDANCE No matter how much the Banking Bureau tried, sooner or later a failure would occur. Banks occasionally became insolvent, usually from poor management. With the transformation of the postwar banking system, however, it was clear that a number of financial institutions would not successfully make the transition. Aware of this, the bureau tried to arrange a soft landing. By the 1980s, the

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biggest problem seemed to rest with the 68 sogo banks. Regulated under the Sogo Bank Law of 1951, they were created primarily to lend to small businesses. They had received some additional authority to engage in commercial banking activity in 1981. Nonetheless, limitations on their business made them less at­ tractive as acquisition candidates and restricted their ability to diversify. Their problems were likely to grow substantially once interest rates were fully deregulated. With the increase in the cost of funding, many lacked a profitable enough base of business to cover the additional costs. In a more competitive environment, sogo banks would be squeezed at both ends. They found them­ selves competing with regional banks for larger borrowers and with credit unions for smaller ones. The Banking Bureau had some time to deal with the problem. With interest rate controls still in place, the banks had not felt the full effects of a deregulated market. The bureaucratic decision was made to encourage sogo banks to convert into commercial banks, something that would facilitate mergers. Initially, the approach was ad hoc. Nishi-Nippon Sogo, the largest sogo, merged with Takachiho Sogo, a troubled financial institution. Rewarded for taking on the addi­ tional liabilities, Nishi-Nippon was allowed to convert to an ordinary commercial bank, the first time this had occurred since Taiyo did so in 1968.6 The Bureau, however, needed a more systematic approach. The task fell to Sadaaki Hirasawa, the director general. He was given a three-year term as head of the Banking Bureau to handle the problem, an unusually long period of continuity. During his tenure, sogo banks were given the option of converting either to commercial banks or credit unions. Confronting the need to ‘‘restruc­ ture or die,” they decided as a group to convert to ordinary commercial (secondtier regional) banks. Having converted, they would be easier to merge should the need arise. Some would eventually combine with larger, healthier banks and disappear. In 1990, San-In Godo, a mid-sized regional bank, absorbed the recently converted sogo, Fuso. Others would merge and become larger, presumably lower-risk, financial institutions. In 1991, Kumamoto and Hyogo became the first two former sogos to do exactly that. The Banking Bureau’s management of the problem contemplated a gradual and soft decline in the number of second-tier regional banks, giving the most at-risk categories of banks and securities companies time to establish a more competitive position or to merge with stronger financial institutions. Circum­ stances, however, did not cooperate. Despite pressure to merge, the bureau con­ fronted the same problem that plagued earlier efforts. Small banks not yet on the edge of failure resisted the entreaties to combine. As a result, the 1990s opened with a number of marginally solvent banks, something known to regulators. The end of the bubble economy shattered the seemingly placid financial system. The protracted economic slowdown made some failures inevitable. Traditional policies of the Banking Bureau were about to confront a vastly altered landscape.

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BURSTING THE BUBBLE At the beginning of the 1990s the Banking Bureau’s approach was business as usual. When a failing financial institution surfaced, the preferred approach was to arrange a merger with a healthier competitor, the usual solution in the postwar era. The entire transaction was arranged secretly, allowing the bureau to announce simultaneously both an insolvency and a rescue. By the early 1990s, however, everything had changed. Large numbers of financial institutions stood on the edge of insolvency. Continued reliance on secrecy and non-disclosure of financial problems meant that the market never knew which bank would fail next, causing a general loss of confidence in the financial system. Moreover, resistance developed to the rescue plans among “ healthy” banks. They suffered during the economic slowdown and were not particularly predisposed to acquire failing banks. With the number of failures increasing and the traditional means of engendering a rescue inoperable, the bureau’s approach to regulation had to change. Resistance was not the only problem. Rescue operations were determined in secrecy, with financial regulators identifying the putative acquirer and negoti­ ating the terms. As the problems deepened and the other banks refused to par­ ticipate, the process took substantially longer. Invariably, matters leaked to the public before any solution had been devised. These dynamics explained the bureau’s worst public relations disaster, the collapse of Cosmo Credit. Founded in 1952, Cosmo was the largest credit union in Tokyo and the fifth-largest in the country. Cosmo’s excessive and risky ex­ pansion apparently came from the president’s effort to grow the credit union into a commercial bank. The desire to become a commercial bank reflected an attempt to deal with the changing realities in the financial system. The Banking Bureau had been resolutely trying to shrink the ranks of credit unions. Survival was more likely for any entity that could jump into the next category of financial institutions. Rapid growth, however, carried obvious risks. By the time the credit union failed, 75% of its loans were nonperforming. A relatively small financial institution, Cosmo’s collapse was notable not be­ cause of the size of the failure but because of the public reaction. Cosmo was subjected to an old-fashioned run, something not seen in Japan since before the war and thought extinct in an era of deposit insurance. Lines fonned at the 24 branch offices, with withdrawals totaling ¥91 billion, or 20% of all deposits. Only emergency loans from the Bank of Japan— the first since the 1965 bailout of Yamaichi— kept the event from becoming a complete rout. The matter had become public not because regulators owned up but because a newspaper, the Mainichi Shimbun, revealed the sorry financial state of the credit union. The story came out on a Saturday and the run began the following Monday, reflecting deep concern with the soundness of the banking system. The

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problems of the bank, therefore, were publicized before the Banking Bureau had fully devised a solution. The situation caught the Ministry flat-footed.7 Once the run began, however, the government reacted swiftly. The Tokyo government issued an order suspending the credit union from all operations except withdrawals, the first time the power had been used since the 1960s. The central bank promised to provide necessary credit, invoking a rarely used emer­ gency provision. Soothing statements concerning the repayment of depositors were made by the finance minister, Masayoshi Takemura, and Yasushi Mieno, the governor of the Bank of Japan. It would be the first and last run during the post-bubble period. Resistance to the rescue operations, although unusual, could initially be ex­ plained by exceptional factors. Mergers were increasingly difficult to arrange for failing banks located outside of the major urban centers. Toho Sogo illus­ trated the difficulties. The only sogo not allowed to convert to a commercial bank, Toho found itself overdependent on shipbuilding loans as the industry collapsed. With bad loans estimated at ¥30 billion, Toho had the misfortune to own a branch network in Ehime prefecture. Few banks wanted Toho and its isolated branches. The government, therefore, designated Iyo, the largest regional bank in the area, as the rescuer. Iyo, how­ ever, balked. Despite heavy government pressure, the regional bank refused to absorb the sick financial institution. Only after the bureau agreed to provide financial incentives in the form of low-interest loans from the deposit insurance system and arranged for the sale of some of the branches did Iyo finally agree to the merger. Iyo’s resistance was something new for financial regulators. The regional bank was having its own problems and had little interest in exacerbating matters by absorbing a sick financial institution. Nor did Iyo have to worry that a competitor would acquire the bank. With problems throughout the financial markets, few other banks had any interest in absorbing the failing sogo. Iyo ultimately con­ sented to buy the bank but only after protracted regulatory pressure, significant financial inducements from the deposit insurance system, and an agreement by some city banks to share the acquisition costs by acquiring some of Toho’s branches. By mid-decade, the Deposit Insurance Corporation had become a regular par­ ticipant in bailouts. Otherwise, however, things were much as they had been. The Banking Bureau kept insolvencies hidden from the public and continued to secretly strongarm commercial banks into rescuing failing financial institutions. Crises were handled on a case-by-case basis, with no attempt at a comprehensive solution. The practice remained to opt for forbearance and not shut down sick banks in the hope that the economy would improve and allow them to recover. The doctrine of no failures, therefore, continued to survive, but at a growing cost. The precarious state of lower-end financial institutions threatened to further sap administrative energy and cause harm to the financial system. As sick banks

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became more common, the amount of bad debt increased. Commercial banks rapidly lost interest in taking on the liability. The impact on competitiveness— particularly as credit ratings fell— grew. The Banking Bureau prevented failures but only by shifting the costs to other finan­ cial institutions. Doing so kept the relatively small deposit insurance system intact but only by imposing the costs of the bailouts on larger banks, which were themselves struggling with serious financial problems. Nonetheless, the bureaucracy seemed curiously unable to face reality and adjust the policy. Moreover, even they did not know the true extent of the problem. Through the first half of the 1990s, the Banking Bureau lacked ac­ curate, comprehensive numbers about the total quantity of bad loans in the financial system. It was a form of deliberate ignorance, as if knowledge of the seriousness of the problem would have forced a bureaucratic response. The bureau was also trapped by its own hidebound approach to regulation. Bureaucrats lived in fear that with a single bank failure, a torrent would be unleashed. No bureaucrat wanted to have this happen on his or her watch. Better to have the financial system undergo incremental harm through additional res­ cues than to be responsible for a sharp and potentially damaging break with existing policies. THE END OF FORBEARANCE By early 1995, the Banking Bureau could still claim that no bank had failed. Technically accurate, the statement amounted to a sleight of hand. With credit cooperatives and shinkins failing, trust and second-tier regional banks drowning in bad loans, and the deposit insurance system all but bankrupt, it was a bit disingenuous to suggest that stability still reigned, even if no commercial bank had yet failed. Rather than step in and close the sick banks, however, bureaucrats opted for a policy of “ forbearance.” Forbearance meant that the bureau would not force banks to fully disclose and write off their nonperforming loans or shut down insolvent financial institutions, in the hope that the economy would recover and allow them to return to health. By delaying the eventual collapse of sick financial institutions, the severity of the problem only became worse. With the economy not recovering, the quan­ tity of bad loans continued to grow. Moreover, each collapse and rescue exposed the Banking Bureau to public hostility and criticism. Changing of the Guard With the assent of Yoshimasa Nishimura as director general in 1994, however, the policies of the Banking Bureau finally began to undergo significant change. Nishimura was not an obvious candidate to lead the reform effort. His bureau­ cratic career provided little training for the relentless crises that occurred under

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his watch. With most of his tenure spent in the Budget Bureau, he had little experience or expertise in banking issues. In many respects, however, his willingness to innovate arose from a lack of alternatives. Upon ascending to the top of the Banking Bureau, Nishimura quickly realized that the postwar doctrines traditionally used to resolve crises no longer worked. Forbearance had only made matters worse and the excessive reliance on secrecy had become counterproductive, causing a general loss of confidence in the entire financial system. For Nishimura, the bankruptcy of the postwar approach became apparent with the collapse and rescue of Tokyo Kyowa and Anzen Credit. For the first time, he confronted an outright refusal of banks to absorb the sick financial institu­ tions. Moreover, his reliance on secrecy to conduct negotiations resulted in harsh public criticism and allegations of favoritism. Thereafter, Nishimura resolved to learn the full extent of the problem, some­ thing that had never been done before. This meant obtaining data from the prefectural governments on the problems of agricultural cooperatives and credit unions, financial institutions under their supervision. It also meant updating the bad loan estimates for commercial banks in recognition of the continued decline in real estate prices. The results of the evaluation shocked Nishimura. The comprehensive problem was far worse than had previously been thought. He could see exactly how unprepared the financial system was for the looming and inevitable wave of failures. Neither the declining resources of the Deposit Insurance Corporation nor the contributions of commercial banks could absorb the burgeoning amount of bad debt. Three things flowed from the realization. First came the hard realization that some financial institutions were simply beyond salvation. For those financial institutions, Nishimura jettisoned forbearance, an approach that had only exac­ erbated matters. It would be under his tutelage that the first banks in the postwar era would fail. Second, a new system was needed to handle the liquidation of failed financial institutions. Reliance on secrecy and contributions from commercial banks no longer sufficed. As a stopgap, Nishimura would, for the first time, seek public funds to pay some of the costs of liquidating insolvent financial institutions. He also, however, developed a framework for a more systematic approach. It was under his guidance that the Diet authorized the creation of the Resolution and Collection Bank, a specialized financial institution designed to liquidate failed banks. Finally and most significantly, he fundamentally restructured the relationship between regulator and regulated. Banks would have to improve substantially their disclosure of bad loans until they met international standards. Moreover, the bureaucracy would no longer turn a blind eye to their problems but would develop objective responses depending upon the seriousness of the problems.

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Banks and bureaucrats were about to enter an era where the relationship would be far less congenial and far more distant. The First Failures A commercial bank finally failed in 1995. The Banking Bureau now con­ fronted what it had long feared, the public collapse of a financial institution. The absolute of no failures was over. Yet runs on banks did not occur; the expected worst-case scenario never materialized. The culprit was Hyogo Bank. A former sogo, Hyogo had converted to a commercial bank with all the others in the late 1980s. The largest of the secondtier regionals, the financial institution had assets of about ¥4 trillion, ranking among the top 200 banks worldwide. Hyogo was in trouble, something known to the Banking Bureau and the Bank of Japan at least since 1993. Nonetheless, under the policy of forbearance, the bureau allowed the financial institution to continue to operate. The bureau even inserted Masateru Yoshida, a retired bureaucrat, as president, to oversee efforts to return Hyogo to financial health. The expectation was that he would do so without any major surgery on the bank’s operations. Matters, however, only became worse. Aware of Hyogo’s problems, Nishimura insisted on a thorough inspection and an assessment of the Bank’s actual financial condition. Proactive and decisive, Nishimura knew that the investigation might uncover facts that made continued inaction impossible. That, in fact, occurred. The examination established that the financial condition of Hyogo was beyond repair. With no rescue in sight and the bank’s financial condition hopeless, Nishimura abandoned the policy of forbearance and let the bank fail. When the plug was pulled, Hyogo had ¥1.5 trillion in nonperforming loans, 55% of the total. The assets were transferred to a newly created financial institution. With that, Hyogo disappeared. Although the worst had finally occurred, the Banking Bureau discovered something unexpected. The disappearance of Hyogo Bank caused no major con­ vulsions in the banking system, no widespread panic among investors. If any­ thing, the markets were relieved that such an obviously sick bank had been eliminated. Hyogo’s failure was a watershed event. In addition to the reality of a failure, the steps taken to mitigate the consequences did not involve the usual secret negotiations and absorption by a healthy bank. The public for the first time learned the true extent of an unhealthy bank’s problems, information not dis­ closed in earlier rescues. Making this type of information available went against the bureaucratic grain but there was little alternative.8 In one sense, however, Hyogo’s insolvency was not a complete break with the traditional approach. Midori, the new bank formed to take over Hyogo’s operations, was funded by contributions from the Deposit Insurance Corporation

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and the commercial banks. This would be the last time the bureau would succeed in using moral suasion to induce commercial banks to fund a bailout. The second failure of a commercial bank quickly followed, but the growing experience of the bureau became apparent. This time it was Taiheiyo Bank, a.k.a. Dai-Ichi Sogo. From public statements, Taiheiyo seemed on the road to recovery, even announcing a profit of ¥66 million in 1994. The following year, however, demonstrated the accuracy with which financial institutions maintained balance sheets. The bank incurred losses topping ¥180 billion, mostly a result of nonperforming loans. Apparently aware that yearend financial statements would disclose these losses, the Banking Bureau took action. Rather than spend additional and fruit­ less time trying to arrange a bailout, officials from Sakura Bank, at the request of the bureau, announced at a midnight press conference that the smaller bank had become insolvent and that a rescue plan was in place. The late-night an­ nouncement was unusual. The steps were, however, taken in an effort to avert a run. Better to appear a bit unseemly than to have a repeat of Cosmo Credit. Despite the constant state of crisis in the banking sector, the bureau was learning. The failure of Hanwa Bank, another former sogo, showed how far the MoF had come. The bank had a troubled past, including the murder of a vice president in 1993. It also had a retired MoF official as president, Takeshi Shinkyo. Following an inspection that revealed nonperforming loans totaling 30%, the MoF issued an order suspending the bank’s operations under Article 21 of the Banking Law, the first time in the postwar period a suspension order had been issued against a commercial bank. Hanwa also had the distinction of being the first failure not to have deposits transferred to another bank. Nonperforming loans were purchased by the Deposit Insurance Corporation, with the remainder liquidated. No bank would carry on Hanwa’s business. This was an out-and-out liquidation of a failed bank, a re­ markably direct bureaucratic approach.

Bureaucratic Paroxysm Nishimura and the Banking Bureau had effectively put an end to the postwar policy of no failures and the practice of forbearance. It was not enough, how­ ever, to close a few banks. In place of the existing ad hoc treatment, the failures required a more institutional approach. An organization for handling the failures was needed, with funding to pay the costs coming from sources other than healthy commercial banks. The bureau also needed to impose objective policies designed to notify financial institutions about the circumstances that would gen­ erate a bureaucratic response. In resolving these issues, Nishimura looked to examples overseas. He devel­ oped particular interest in the Resolution Trust Company. Created to solve the savings and loan fiasco in the United States, the RTC engaged in a swift but

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brutal resolution of the crisis by closing thousands of financial institutions, dis­ posing of their assets and prosecuting wrongdoers. In a country where lifetime employment still reigned and matters were re­ solved by public apologies rather than jail time, adopting a model based on what was done in the U.S. was neither inevitable nor obvious. Nishimura’s decision, therefore, was controversial, even within the Banking Bureau. Nonetheless, the die was cast. An organization would be created to take over the outstanding assets of the failed financial institutions and rigorously seek repayment. The same Diet session that agreed to provide public funding to assist the bailout of the jusen also adopted legislation designed to create the entity. Tokyo Kyodo Bank, which had been created to absorb the assets of the Tokyo Kyowa and Anzen Credit, was renamed the Resolution and Collection Bank and con­ verted into an organization designed to handle the liquidation of failed credit cooperatives. Assets of failed financial institutions would be transferred to the Resolution and Collection Bank with rigorous steps taken to collect outstanding loans. An institutional response, however, was not enough. At the same time finan­ cial institutions were placed on notice that the old rules no longer applied. Nishimura raised the premium for deposit insurance 600%, imposing more of the costs of the bailout on the entire industry. He also, however, made clear that banks had to become responsible for the accuracy of their financial disclosures, including the quantity of bad loans. The seemingly obvious shift in policy had dramatic ramifications. Until Nishimura insisted on changes, banks were only inspected by examiners from the Banking Bureau or the Bank of Japan every three years. As a result, financial institutions waited for the inspection before conducting a qualitative review of their loan portfolios. Moreover, they relied extensively on the analysis provided by the examiners. Under Nishimura, that would change. With a guiding philosophy of “ self examination,” batiks would be required to conduct reviews every six months, consistent with international standards. The reviews would be subject to ex­ amination by outside auditors. Moreover, beginning in April 1998, they would be expected to provide the same standards used by bank examiners in classifying loans.9 Second, the disclosure would have important ramifications. There would be no more forbearance. The bureau would react with “ prompt corrective action” whenever capital adequacy ratios fell below certain levels. In those cases, a bureaucratic response would be automatic and could even involve the closing of the financial institution. The process would be transparent, involved little bureaucratic discretion and promised to dramatically alter the relationship be­ tween banks and bureaucrats. In effect, the approach gave banks a firm deadline. As a result, financial institutions had no choice but to accelerate the disposition of bad loans. The deadline also, however, applied to bureaucrats. The failure of Hokkaido Taku-

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shoku came after the Banking Bureau realized that there would not be time to arrange a rescue operation before the bank had to disclose the extent of its nonperforming loans. With time running out, both bankers and bureaucrats threw in the towel and opted for liquidation. By 1997, the new policies were beginning to bite and to cause a fundamental restructuring in the Japanese financial system. Healthy banks like MitsubishiBank of Tokyo disposed of their problem loans in larger numbers, prepared to move forward. At the same time, more and more financial institutions tilted to reality and decided to liquidate. The best indication of the seriousness of the approach was the response by financial institutions and politicians. More marginal banks began to beseech their political allies to put pressure on the Banking Bureau to delay imposition of the new reporting requirements. By early 1998, the LDP had succeeded in inducing the bureau to postpone for a year the implementation of the new approach. LESSONS LEARNED In the 1990s, the Banking Bureau confronted a growing wave of bank failures. One solution would have been to simply step back and let the market sort out who would survive and who would fail. At the beginning of the decade, that would have been beyond peradventure. The bureau was not ready to accept a single failure, much less a raft of insolvencies among banks and securities firms. Moreover, the MoF had a history of managing the financial markets through periodic crises. Despite a dramatically changed financial market, officials there were not prepared to abdicate control. Another solution would have been to openly discuss the issue, but to provide assurances that the system was strong enough to address the problems. This ran directly counter to the paternalistic approach that secrecy was the best way of dealing with any crisis. Banks were allowed to keep the true extent of their problems under wraps, with the Banking Bureau periodically announcing that the crisis was over. The problem with this approach, as the bureau learned, was that matters in the financial markets did not cooperate. Every failure, and there were plenty, illustrated that things were far worse than the bureau admitted. Each collapse cost the MoF dearly in credibility and made the public wonder whether in fact regulators had a grip on the problems confronting the financial markets. Gradually, however, bureaucrats opted for an approach that allowed the most unhealthy financial institutions to fail. Indeed, there was little bureaucrats could do about it. More positively, however, they learned that a failure could occur without causing a system-wide failure. They were not pleasant experiences. Nonetheless, they cleansed the market of poorly run and inefficient financial institutions. Even large financial institutions would not be immune, as the failure of Hok­ kaido Takushoku showed. At the same time, however, neither the Banking Bu­

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reau nor the public was ready to pull the plug on all marginal financial institutions. Nor was doing so necessary. While the disastrous performance of some banks arose from poor management, the demise of the postwar financial system was also to blame. Banks were dealing with the consequences of having applied traditional banking principals at a time when the underlying premise of financial regulation had undergone a fundamental shift. While some banks were beyond salvation, others, on the margin, could sur­ vive in the new order, once the most immediate crisis passed. Bureaucratic policy, therefore, no longer tolerated forbearance, irrespective of the cost. At the same time, however, not every unhealthy bank having difficulty making the transformation would be required to liquidate. One other lesson was clear. The MoF would have to reexamine the practice of rote adherence to a bureaucratic imperative such as the proscription on bank failures. Had the absolute been abandoned sooner, the Banking Bureau would have had more time and less embarrassing circumstances to develop the least disruptive method of liquidating failed financial institutions. Systems would have been in place and employees trained on how to best negotiate the disso­ lution of the sick bank. Officials would have had less concern about uncovering a failing financial institution and been more willing to follow procedures to handle the problem. The one vestige of the proscription on failures that had not yet been aban­ doned, however, concerned the efforts at consolidation. When bank failures did finally occur, the bureau found itself dealing with financial institutions that were both too big to fail and too big for another bank to rescue. In part, the circum­ stances resulted from a financial market that had placed excessive emphasis on consolidation. While banks would have any number of reasons to merge, new participants would have equally legitimate reasons to enter the market. Moreover, new en­ trants would provide an additional source of competition, something not desired by regulators for most of the postwar period but now more appealing. Finally, the formation of new banks might provide a landing pad for employees of failed banks who found themselves out of a job. Whether the Banking Bureau would take a more lenient attitude toward the issuance of banking licenses remained to be seen.10 The bureaucracy would have to learn to appreciate greater competition. It would also have to overcome the innate fear that smaller banks would cause most of the problems in the financial markets. In an era that permitted bank failures, errant participants could be allowed to go out of business.

CHAPTER 8

The P roblem of Inform al R elations: The D aiw a B ank S candal

In the postwar system, relations between regulator and regulated were highly personal. Officials would meet, often at social occasions, and solicit or exchange information. Ministry career officials, particularly those having no real financial expertise, relied on these contacts to provide ideas and solutions to problems in the financial markets. Industry officials, in turn, used them to glean the policy directions of the MoF and to influence the ultimate result. The approach placed an emphasis on personal contact and a deemphasis on official reports. Bureaucrats wanted to know about a problem before it appeared in an official document. Moreover, as long as they knew, public reports could be less revealing, particularly where disclosure might destabilize the financial markets. Informal contact also provided Ministry officials with an out if anything went wrong. With a thin staff, the Banking Bureau traditionally placed the obligation to investigate on the financial institution. Until an investigation was completed, bureaucrats had an excuse not to take action. At the same time, the bank, se­ curities firm or insurance company was able to work out the problem internally, without having to inform the public. The system worked well for most of the postwar period. In general, the MoF was able to learn about crises before they surfaced publicly. By the time they became generally known, a solution had been devised and panic averted. As the economy was transformed, however, the approach no longer worked. For one thing, it depended upon a willingness of private-sector entities to accurately report matters to bureaucrats. Problems in the post-bubble economy, however, were far more severe, with financial institutions confronting draconian consequences. Accurately reporting bad loans could, for example, lead to seizure by banking officials and liquidation. Alternatively, bureaucrats might push to

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have the unhealthy financial institution merge with a healthier one. Either way, the continued survival of the problem bank or securities firm would be at issue. In these circumstances, financial institutions proved less willing to reveal the information, informally or otherwise. When matters became known, therefore, the MoF was often caught off guard. Even worse, information would leak to the public before any solution had been devised. These circumstances caused embarrassment and gave the impression that the MoF had lost control of the situation. The system of informal reporting also failed to take into account sensitivities of foreign regulators, many of whom tended to prefer more arm’s-length rela­ tionships with the financial industry. Moreover, Japanese financial institutions also seemed to take a less rigorous approach to reporting violations to foreign regulators. Mostly, though, the informal relationship evolved into a practice of respon­ sibility avoidance. As long as bureaucrats could pretend not to know, or waited until the financial institution completed its investigation, they could avoid dif­ ficult, controversial, potentially career-ending decisions. This pattern of behavior could not continue in the transformed economy. The unreliability of official reports meant that the public could not assess the con­ dition of any particular financial institution. The result was a general loss of confidence and the imposition of a risk premium on all banks, healthy and unhealthy. The problem of informal relations surfaced dramatically in connection with the debacle in 1995 over the trading losses by Daiwa Bank. A rogue trader in New York lost $1.1 billion while trading in government bonds. That was bad enough. When officials within the bank found out, they informed bureaucrats within the Banking Bureau but decided to refrain from reporting the matter to U.S. regulators for six crucial weeks. Bureaucrats in the Banking Bureau neither reported the matter to U.S. regulators nor ordered Daiwa to do so. When the matter became public, Daiwa found itself in the midst of a firestorm. The Federal Reserve Board ordered the bank to shut down and leave the country. The U.S. Attorney’s Office criminally indicted the bank and two employees. To resolve the charges, Daiwa paid a fine of more than $300 million. As the dust settled, the very independence of the bank remained in doubt. In handling the losses, the Banking Bureau and Daiwa employed a quintes­ sential Japanese approach to the problem. Daiwa had every interest in delaying disclosure of the trading losses, but realized that the Ministry had to be informed. The bank chose to do so in an informal meeting among high-ranking officials. The bank knew that in these circumstances the MoF would give an indeterminate response, at least until Daiwa had completed its investigation. The approach also benefited the Banking Bureau. The bureau wanted to avoid taking any action that might destabilize the financial markets. Having been told informally that the investigation was not complete, bureaucrats had no obligation to act until completion of the investigation. With their hands full with other

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financial crises, top officials in the Banking Bureau encouraged Daiwa to com­ plete the investigation but otherwise took no action in response to the infor­ mation. This time, however, the approach backfired. The sensibilities of foreign reg­ ulators were at issue and this was not an acceptable response. The scandal once and for all showed the inherent weaknesses in a system that made the avoidance of responsibility a central component of bureaucratic behavior and, as a corol­ lary, permitted a vague and informal interaction that could delay any firm re­ sponse from regulators. It also showed the problems of a system that did not place adequate emphasis on the accuracy of public disclosure. THE SCANDAL An Osaka-based entity, Daiwa Bank was one of the largest financial institu­ tions in the world. Transcending mere size, the bank also had a unique place in the Japanese financial system. For most of the postwar era, Daiwa represented the only city bank with the authority to engage in trust activities. Although city banks had been allowed to conduct trust activities during the war, the MoF forced them out after the conflict. They were required to divest their trust departments. The only exception was Daiwa. Unlike other city banks, Daiwa refused, a rare postwar example of an unwillingness to accept guidance from the Banking Bureau. The director general of the bureau criticized the re­ fusal, characterizing the bank as under bad management. Rumors were rife that the MoF did not forget the slight and penalized the display of independence by authorizing fewer branch offices, permanently consigning Daiwa to the second tier of city banks. Daiwa was also slighted with respect to overseas offices. In the immediate post-occupation period, most of the international offices went to the bank of Tokyo. Gradually, however, the MoF allowed the large commercial banks to expand into foreign markets, with branches in New York and London. The largest banks (Sumitomo, Dai-Ichi, Fuji, Mitsui, Mitsubishi, Sanwa) were per­ mitted to expand first, with the second-tier city banks, a category that included Daiwa, only permitted to follow later. By the time of the scandal, therefore, Daiwa had only a modest presence in the U.S. The bank had seven branches, including two in New York, seven agency offices, and 14 representative offices in 11 states. The bank also operated a single state-chartered financial institution, Daiwa Trust Bank Company. Subject to the same restrictions imposed on all domestic banks in the United States, Daiwa could not engage in a full range of financial activities. The bank could not sell insurance or underwrite corporate stocks or bonds. The branches could, however, deal in bonds issued by the U.S. Government. As a result, the New York Branch held a significant quantity of government bonds. Some were investments made directly by Daiwa. Others were held on behalf of clients. For a fee, the branch would hold the securities and remit

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interest payments. The branch did not, however, have physical possession of the securities, but left them with Bankers Trust, a U.S. bank, in a custodial account. It would be Treasury obligations that generated Daiwa’s huge trading losses. As subsequently became clear, the trading losses were not Daiwa’s first brush with the U.S. regulatory system. Daiwa’s problems began in 1984. That year officials discovered that Daiwa Trust, a subsidiary of Daiwa Bank, had incurred a loss of approximately $30 million in unauthorized and off-the-books trading in U.S. Treasury obligations. Senior management in Japan instructed officials not to disclose the loss to U.S. regulators or to the American officers and directors of Daiwa Trust. Thereafter, efforts were made to keep the losses secret and to recoup the losses through additional trading. It only made matters worse. Over a three-year period, the loss climbed to $97 million. Daiwa Trust did not reflect the loss on its balance sheet, concealing the matter from the New York Banking Department and the Federal Deposit Insurance Corporation. Senior managers in Japan apparently instructed Daiwa Trust to move the loss to an offshore entity. The scheme to hide the loss succeeded. Only when the $1.1 billion loss surfaced did the earlier trading problems come to the attention of U.S. regulators.1 Daiwa ran into other regulatory problems. There had been no tradition of inspections of the New York branch by the Federal Reserve Board. With the adoption of the Foreign Bank Supervision Enhancement Act, however, the Board received inspection authority, starting in 1992. Although Daiwa had been operating a branch in New York since the 1970s, it was unprepared for the more intense scrutiny provided by the Federal Reserve. The initial inspection presented Daiwa with an immediate problem. Toshihide Iguchi, the trader who lost $1.1 billion, wore two hats. He was responsible both for trading in government securities and for their custody. The two positions created the risk that someone losing money on trading activities could cover the losses by selling securities from the custodial accounts. That, of course, was exactly what Iguchi had been doing. Officials in the branch, however, wanted to prevent U.S. regulators from uncovering the problem. The New York Federal Reserve scheduled an examination of Daiwa’s down­ town branch. Rather than reveal to inspectors that the two functions had been combined, Daiwa employees hid from regulators the fact that trading was taking place in the downtown office. They ceased trading securities and closed the room, with securities activities moved to the midtown office. To disguise the move, lights were turned off and boxes stacked around desks, all in an attempt to create the appearance of a storage room. Representations were also apparently made to bank regulators that trading practices in the office had been discontinued and that traders no longer reported to Iguchi. As the bank would later admit, the activities involved an intentional effort to mislead Federal Reserve examiners. The deception came to light the following year when inspectors returned.

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Apparently having discussed the matter with counsel, Daiwa officials admitted what they had done. They gave as an excuse the fear of discovery by the MoF. The Banking Bureau had only authorized trading at the midtown office and Daiwa claimed it wanted to avoid any reference in a report to trading activities at an unapproved site. The $1.1 billion trading loss first became known within the bank in the sum­ mer of 1995. Iguchi, now executive vice president of the New York branch, had been speculating in U.S. Treasury obligations for more than twelve years, making some eight thousand trades. To hide the mounting losses, Iguchi fabri­ cated documents and sold bonds belonging both to customers and to Daiwa. Ultimately over $600 million in securities would be used to cover up the im­ proper trading. Iguchi’s activities had been facilitated by sloppy internal procedures within the bank branch. Despite having been warned by regulators, he continued to function as head of both the securities trading and custody departments. He also conducted his trading activities in a smaller office, away from the primary trad­ ing operations, resulting in less scrutiny. With the cover-up getting harder to maintain, Iguchi finally broke down and revealed the loss to superiors in Japan in a 30-page letter dated July 17, 1995. The letter was the first of a series detailing his activities. He revealed that the crisis had begun with a loss of $200,000 in 1984, which he had tried to recoup through additional trading, only to see the amount climb. Iguchi disclosed the amount of the loss and his practice of hiding losses by selling securities “ that we hold for our clients as their custodian.” He acknowl­ edged forging statements and apparently attached copies. It was not a sophisti­ cated scheme. He admitted that ‘ ‘at the beginning I was typing the balance sheets all by myself. But since it was so time-consuming around 1991 I started to use a word processor.” Iguchi identified specific securities and specific clients. He also provided some gratuitous advice on how to handle the problem. Recognizing that discovery by U.S. regulators would place Daiwa in “ an extremely disadvantaged position,” Iguchi recommended that the loss be transferred back to Japan. The reaction in Japan was shock. Calls were immediately placed to Iguchi to discuss the problem. It quickly became apparent that any cover-up would require Iguchi’s assistance. A delegation of bank employees, including Hiroyuki Yamaji, a managing director and the person in charge of Daiwa’s international business, went to New York to look into the problem. In late July, officials from Japan met with Iguchi at the Park Lane Hotel in New York.2 It became clear at the meeting that the bank had no intention of immediately disclosing the loss. Daiwa knew that the matter could not be kept secret indefinitely and decided from the outset that disclosure should eventually occur. Nonetheless, the initial approach was to opt for delay. Immediate supervision of the problem fell to Masahiro Tsuda, the general manager of the New York branch. Tsuda had nothing to do with the loss and

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had arrived in the United States only a few weeks before Iguchi sent his letter. Nonetheless, as the person running the office, he would follow instructions from headquarters, even if it meant violating U.S. law. In a curious twist of fate, Tsuda was uniquely trained for his new task. He had served at Daiwa Trust when the company had hidden the $97 million loss from U.S. regulators. With the decision to delay disclosure of the loss, a cover-up began. According to allegations made by U.S. authorities, steps were taken to disguise the loss from regulators and transfer it back to Japan. Once in Japan, the problem could be handled without having to consider U.S. sensitivities. As one bank official reputedly stated, the goal was to get the New York branch out of the matter. To maintain the cover-up, documents had to be falsified.3 Sale of securities from customer accounts would need to continue. More ominously, the bank had to file false reports with U.S. regulators. The branch submitted ‘'call reports” to the Federal Reserve Board detailing the branch’s assets and liabilities. The one filed for the period through the end of July listed $616 million in “ trading assets.” The amount included $600 million in short-term Treasury obligations that Iguchi had sold to cover his trading losses. The report, therefore, substan­ tially overstated the assets held by the branch. Although continuing the investigation, officials at Daiwa knew by the end of July that a substantial loss had occurred and by early August the extent of the loss. As the bank would later admit, officials investigated and “ quickly” un­ covered the extent of the trading loss. In fact, determining the precise dollar figure involved a relatively simple calculation. Bankers Trust always sent a monthly statement reflecting the amount of securities on account. To disguise the fact that he had been selling the securities, Iguchi prepared false statements showing a greater quantity. Simply comparing falsified and non-falsified state­ ments would reveal the extent of the loss.By early August, bank officials knew enough that they could no longer with­ hold information from the MoF. Daiwa chose to inform the MoF in a very traditional way. Akira Fujita, the president of the bank, scheduled a dinner with Yoshimasa Nishimura, the director general of the Banking Bureau, for August 8. Before dinner, Fujita told him about the problem, including receipt of the 30page letter submitted by Iguchi and the potential size of the loss. The bank indicated that it needed a few months to complete the investigation of the thousands of trades undertaken by Iguchi. With the Banking Bureau wrestling over a series of failing credit unions and confronting the problem of the insolvent housing loan companies, Nishimura had his hands full. Rather than take affirmative steps, he accepted the bank’s insistence that further investigation was necessary. He did tell Fujita that the timing was very bad and would coincide with the end of the quarter, causing “ chaos in the market.” Daiwa, which was none too eager to disclose the scandal, got the response it Wanted. Nishimura knew that the matter was serious. Daiwa would only use its president to convey to the Banking Bureau matters of the utmost importance.

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Nonetheless, Nishimura left completion of the investigation and the timing of disclosure to Daiwa. The bank interpreted the MoF’s approach as supportive of delay in disclosure. In the words of the bank: “ [T]he MoF gave priority to the convenience of the Japanese government and implied that it would be absolutely the worst timing if the incident were to come out in September. MoF’s comment reinforced Daiwa’s own business decision to delay disclosure, which was in violation of Daiwa’s duty to notify the authorities of the losses under U.S. banking regula­ tions.” 4 In fact, Nishimura would vehemently deny that he counseled delay.5 While he expressed concern about the timing of disclosure, he wanted Daiwa to reveal the problem sooner rather than later. Nonetheless, by failing to take more affir­ mative action, he ceded discretion over the matter to Daiwa. In that sense, it was a traditional bureaucratic response to a financial crisis. After reporting the matter to Nishimura, Daiwa’s efforts at damage control continued. A meeting was held in Japan in the middle of August between Tsuda and several high-ranking bank officials. Tsuda indicated that the extent of the loss had been confirmed but that the investigation was continuing into exactly how Iguchi had lost such a large sum, something that could take a month or more. At the meeting the decision was apparently reaffirmed to delay disclosure until after the end of September. Officials in New York were directed to continue to maintain secrecy. According to participants, efforts were made to transfer the loss back to Japan. Securities that Iguchi had sold would be “ purchased” from New York by the International Treasury Division in Tokyo. The $600 million purchase price would immediately be “ lent” back to the bank’s Tokyo office. The missing securities, therefore, would be transformed into a loan to the bank in Japan.5 To the extent that it was considered seriously, the scheme to transfer the loss back to Japan spoke volumes. Moreover, Daiwa officials apparently thought the problem would be more manageable and result in a more favorable outcome if handled by the Banking Bureau in Japan rather than the Federal Reserve in the United States. Either the MoF was less feared or easier to manipulate. As awareness of the loss grew in the New York branch, employees informed Tsuda of the need to report the violation. They also urged officials to raise the matter with U.S. counsel as soon as possible. The information was conveyed to Tokyo but disclosure was not authorized. Only after Tsuda again requested authority to speak with U.S. attorneys a week later was contact finally approved. Bank officials approached their U.S. lawyers, Sullivan & Cromwell, on September 8. They were advised to report the matter to financial regulators. Even then they dallied, waiting another ten days to disclose the trading losses. At that point, the whole scheme unraveled. On September 12, Fujita phoned Nishimura to inform him in greater detail about the results of the investigation, including the bank’s plans for handling the loss. It took another two days before Daiwa reported the matter to Toshihiko

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Fukui, the senior deputy governor of the Bank of Japan. A day later, a meeting was scheduled with the staff of the New York Federal Reserve and only on September 18 did U.S. banking officials finally learn about the trading loss. With public disclosure now unavoidable, the bank no longer needed Iguchi to help with the cover-up. Daiwa fired him on September 25 and revealed the trading loss to the public the next day. The response by the Federal Reserve was, initially, measured. On October 2, banking regulators ordered Daiwa to cease trading activities in the U.S. Daiwa also had to appoint an independent accounting firm to review the losses and the internal controls of the New York branch. A large trading loss was serious but, for a bank the size of Daiwa, hardly threatening. These measured responses, however, were only the initial salvo. A month later the Federal Reserve brought down the other shoe with a vengeance. In conjunction with state and federal banking agencies, the Federal Reserve Board ordered Daiwa to cease operations in the United States for three years, and to do it quickly. It gave the bank only 90 days to get out. The FDIC also terminated deposit insurance and New York banking regulators announced that Daiwa Trust had to cease doing business. Never before had such harsh actions been taken against such a well established, prominent financial institution. Nor were these the only problems confronted by Daiwa. When the Federal Reserve learned of the trading loss, it immediately informed criminal authorities. On November 2, the U.S. Attorney’s Office for the Southern District of New York issued a 24-count indictment. The counts included concealment of material information from the Federal Reserve and obstruction of a bank examination. Daiwa ultimately pled guilty to 16 of the counts and agreed to pay a fine of $340 million. The penalties were harsh. They certainly- seemed disproportionate to the of­ fense— not reporting a trading loss for six weeks and falsifying reports on assets to the Federal Reserve. Daiwa’s most significant transgression, however, was not the inaccurate report, but the pattern of duplicitous behavior. It had, since the mid-1980s, engaged in almost a continuous process of hiding matters from U.S. regulators. The heavy penalty also had a more emotional explanation. A not particularly sophisticated group of Daiwa employees had succeeded in hiding a billion-dollar loss from one of the supposedly most effective bank regulators in the world. Looking a bit like the Keystone Cops, hauled in front of Congress to explain itself, the Federal Reserve was embarrassed. It took its own failings out on Daiwa. The consequences of the trading loss did not fall only on the bank. Two employees of the bank were also subjected to criminal sanctions. Iguchi, the employee who lost the money, pled guilty to a number of counts, including ones relating to concealment of the losses and deceiving bank examiners. In his court statement, Iguchi indicated that the cover-up was supported by management. The other employee charged was Masahiro Tsuda. He represented the most

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tragic figure in the scandal. He had previously served as manager of the New York office and chairman of Daiwa Trust during the cover-up of the earlier $97 million trading loss. Tsuda, however, pled guilty to one count involving only the concealment of the $1.1 billion, not the earlier trading losses. Tsuda was in the wrong place at the wrong time. Running the New York office, he was assigned the logistical task of hiding the trading loss. In the communal environment of a Japanese bank, he had little choice but to follow the decision of management on how to handle the matter, especially after it had been reported to the MoF. Whistle-blowing was not an accepted tradition in Japan. Had he reported the matter, he would have brought embarrassment to the bank and, perhaps worse, earned the enmity of the Banking Bureau. With life-long employment and strong identification with the firm, Japanese employees simply did not engage in this type of behavior. Tsuda’s only effective option was to protest internally, which he did. Tsuda would eventually lose his job and his retirement benefits, and have his reputation tarnished. He would also plead guilty to a single count that resulted in a fine and two months’ imprisonment. In statements made in court during his plea hearing, he implicated higher-ups in the bank. He stated that the cover-up of the Daiwa Trust losses had also been approved by management in Japan. Finally, Tsuda made clear his belief that Daiwa’s approach had been approved by the MoF. Daiwa’s problems were not limited to the United States. Severe penalties were also imposed in Japan. The Banking Bureau ordered Daiwa to cut in half its international operations, including bond trading. The bank could not accept any additional overseas trust banking business. With U.S. operations gone, business would henceforth be concentrated in Asian markets. In traditional Japanese fashion, the scandal also required a show of contrition and responsibility by bank officials. Top officials, therefore, were expected to resign. Their departures, however, were not left to chance. Pressure for resig­ nations came directly and publicly from both the Finance Minister and the Bank­ ing Bureau. On October 9 the president, Akira Fujita, and two directors resigned to take responsibility for the scandal. Sumio Abekawa, the chairman, resigned following the criminal indictment of the bank by U.S. authorities. The scandal also affected Daiwa’s business in a more direct fashion. The Ministry of Posts and Telecommunications indicated an intention to reduce re­ liance on Daiwa for fund management. The Postal Savings System announced an intent to use Daiwa less to manage its assets. With the organizations subject to considerable government and MoF influence, there was little doubt that they represented continued expressions of bureaucratic anger over Daiwa’s activities. The financial markets were rife with rumors that the scandal had so weakened Daiwa that its continued independence was in doubt. The prediction that Daiwa would merge with. Sumitomo or another large bank did not ultimately come to fruition, probably because of the barrier presented by Nomura, the country’s

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largest securities company. Daiwa Bank and Nomura Securities had longstand­ ing ties, with Tokushichi Nomura having founded both entities. Nomura was Daiwa’s largest shareholder, with 3.3% of the bank’s stock; Daiwa was the fourth-largest shareholder of Nomura. None too pleased with the possible link with Sumitomo, Nomura remained in a position to impede if not block the merger. THE ROLE OF THE MINISTRY OF FINANCE The scandal seemed to be a matter between U.S. regulators and Daiwa Bank. Almost from the outset, however, the Banking Bureau of the MoF became in­ volved. Officials initially defended Daiwa. When it became apparent that bu­ reaucrats knew about the trading loss weeks before U.S. officials, the bureau found itself engulfed in controversy. Ultimately, officials in the highest echelons of the MoF would become involved in an effort to quell the scandal and the finance minister was forced to intervene, all causing considerable embarrassment to bureaucracy. The Reaction The MoF’s reaction to the scandal took a variety of everchanging shapes. Initially, bureaucrats reacted with concern but sought to downplay the crisis. Later, when the MoF’s early awareness of the problem became known, the reaction ranged from defensive to contrite to apoplectic. Never, however, did the Banking Bureau directly accept responsibility for the poor handling of the scandal. Nonetheless, the MoF learned from the debacle. The traditional approach of denial of responsibility gradually gave way to a more forthright approach. Less reliance would be placed on informal relations and personal trust. The bureau­ cratic response ultimately suggested a fundamental change in the relationship between the Banking Bureau and its overseas wards, something long overdue. The Ministry did not initially admit that it had learned of the development in August, six weeks before the Federal Reserve. Instead, early press reports sug­ gested that the Banking Bureau had only learned in September, roughly the same time as U.S. regulators. Not until October 9, almost three weeks after the Federal Reserve Board was notified and two weeks after disclosure to the public, did officials in the MoF own up and admit having been informed in August. Even then, the MoF reacted to the scandal by defending Daiwa and mini­ mizing its responsibility. Officials in the Banking Bureau showed little sympathy toward U.S. views. Kozo Kimura, deputy director in the Commercial Banking Division of the bureau, asserted that Daiwa had done nothing wrong in delaying the report on the trading losses. Moreover, he defended the six-week delay in disclosure as necessary for Daiwa to go through the massive amount of docu­ ments to verify Iguchi’s story.

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The discovery that Nishimura knew well in advance of notification to the Federal Reserve Board was greeted by anger in the United States. As damage control, the Banking Bureau sent Sei Nakai, a deputy director general, to the U.S. to explain the MoF’s actions. The Finance Minister, Masayoshi Takemura, called U.S. Treasury Secretary Robert Rubin to explain the situation. Even afterwards, however, the attitude of the MoF was less than conciliatory. Kyosuke Shinozawa, the administrative vice minister, responded to questions at a press conference by expressing “ deep regret” about the crisis, but otherwise placed the blame squarely on the shoulders of Daiwa Bank. When Treasury Secretary Rubin characterized Takemura’s statement as an apology, an imme­ diate objection emanated from the MoF. Eisuke Sakakibara, director general of the International Finance Bureau, stated that the Ministry had done “ nothing improper.” He denied that an apology had occurred and that at worst, the prob­ lem had resulted from “ a partial failure of communication.” As the criticism of the MoF’s awareness mounted, Nishimura and Sakakibara held a joint press conference before the foreign press, a first in the annals of Ministry practices, to explain what happened. Nishimura characterized the meet­ ing with Daiwa Bank officials as informal and therefore one that required no specific action. Nishimura claimed that he delayed telling U.S. authorities about the trading losses because he had not received the information officially from Daiwa, the bank had not yet completed its own investigation and the Banking Bureau had its hands full, with several failures to resolve. Implicating the Ministry of Finance It was bad enough that the Ministry did not notify regulators in the United States about the problem or instruct Daiwa to do so sooner. Darker rumors circulated that MoF officials were far more culpable. Some suggested that the Banking Bureau had full knowledge of the problem and had ordered the bank to cover up the loss until after the upcoming reporting period. Hiroyuki Yamaji, a Daiwa director who had resigned, more directly impli­ cated the Ministry. Having attended the dinner where Fujita told Nishimura about the trading loss, he contended in an interview given to a Japanese news­ paper that the head of the Banking Bureau specifically stated that it was “ bad timing for this affair to surface.” Given the institutional habits of the MoF, however, it was highly unlikely that bureaucrats instructed Daiwa to delay disclosure. First, Daiwa already had decided on delay, even before informing the Banking Bureau. At most, therefore, Nishimura simply acquiesced in the preexisting Daiwa strategy. Second, for all of the bureaucratic concerns that sometimes impeded effective decision making, the MoF did not have a tradition of ordering obfuscation, at least when directly presented with a problem. A solution would need to be devised, with bureaucrats monitoring the process.

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Finally, bureaucratic traits that interfered with decisiveness applied with equal vigor to attempts to deal with scandal. Nishimura was at the top of the bank regulatory pyramid. It was not the MoF’s way for the top person to act decisively after one contact. Before taking definitive action, Nishimura would have con­ sulted others within the Banking Bureau. Lower-ranking, but more hands-on, career officials would have had an opportunity to participate in the decision­ making process. To think that Nishimura would decisively order a cover-up after a single discussion belied the reality of bureaucratic decision making. Instead, Nishimura’s reaction was in many ways typical. The Banking Bureau, with a relatively small number of examiners, had a tradition of relying on com­ mercial banks to conduct their own investigations. Moreover, the resources of the bureau were already stretched in an effort to negotiate the bailout of Tokyo Kyowa, the failed credit cooperative, and to negotiate public funding for the housing loan companies. Nishimura, therefore, did nothing unusual in telling Daiwa to come back when things had been resolved. The matter illustrated a number of weaknesses in the MoF’s approach to financial regulation. Most obviously, it constituted a reminder of something well known in Japan: that the MoF did not conduct particularly rigorous examina­ tions. The MoF and the central bank had examined Daiwa’s New York branch five times since 1985. Despite the scale of the loss and the sloppiness of the bank’s internal practices, Japanese financial regulators had not discovered the problem. Regulators, therefore, seemed to lack the skill to uncover abuses. The scandal also demonstrated problems with the personal nature of the in­ teraction between the MoF and Daiwa. The Ministry did not need or want to deal with the bad news. The approach, therefore, was to express unhappiness but otherwise take no specific action. When Daiwa came back to the MoF to “ officially” discuss the problem, a solution would have been devised. Bureau­ crats in the Banking Bureau could have refined the approach somewhat but otherwise would have acquiesced in disclosure accompanied by a solution, since the approach would limit the adverse public reaction. At the same time, a vague response allowed the MoF to distance itself from the scandal. Having not been presented with a specific matter and having given an indeterminate response, officials later could (and did) take the position that nothing had been officially approved. Essentially, the Ministry used vagueness to disavow any responsibility. This was not to suggest that MoF officials always refused to act in the face of an obvious scandal, even if told informally. Although Daiwa’s problem in­ volved a huge loss, it was not one that threatened to impair the safety of the bank. The financial institution had more than adequate capital to pay off the liability. Moreover, clients would not lose any money. While their securities had been sold, the bank agreed to absorb the entire loss. No one was injured as a result of continued nondisclosure except perhaps shareholders. Bureaucrats, therefore, had little reason to intervene directly.

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LESSONS LEARNED The Daiwa Bank scandal was unlike any other and a complete disaster for the MoF, both in the behavior it showed and the way in which it was handled. The scandal contained a number of lessons. In Japan, it was used to show the out-of-date nature of MoF regulation. The response of the Federal Reserve dem­ onstrated only too clearly the contrast in two countries’ respective approaches to financial oversight. From the Ministry’s perspective, the worst thing, other than the public pillorying, was the severely damaged relations with financial regulators in the United States. From the perspective of Daiwa, the lessons were even more stark. Relying on the MoF to assist in management of the problem produced calamitous results. Not only did senior people resign and the bank get summarily ejected from U.S. markets, but Daiwa’s very independence was in doubt. Legitimate lessons, they generally missed the most significant implication of the scandal. It was not completely accurate to claim that the transaction occurred because the MoF’s regulatory approach did not coincide with international stan­ dards. It was not news that Japan had a different, more personal, style of over­ sight of banks. The approach did conflict with the more arm’s-length method used by regulators in the United States. This, however, was well known and had rarely caused conflict in the past. Indeed, in many ways the Banking Bureau’s mistakes bordered on the acci­ dental. The problem arose mostly because the bureau had not taken into account the newly imposed oversight by U.S. regulators of Japanese branches in New York. Until the adoption of legislation in 1991, the Federal Reserve Board had no jurisdiction over the U.S. branches of Japanese banks. Nor did the FDIC, since the branches did not accept insured deposits. While the New York State banking authorities did have some supervisory authority, it was not particularly exacting. Officials relied “ heavily” on Japanese regulators and typically “ deferred” to Japanese sensibilities. Thus, while they conducted a number of inspections of Daiwa’s operations, state examiners gen­ erally looked to Japanese officials to oversee the financial institution’s operations in the U.S.7 Until 1991, therefore, problems in the New York branch were largely matters between Daiwa and the MoF. They were handled in the traditional Japanese fashion. In general, issues could be addressed personally, without much concern for the sensitivities of foreign regulators. That was no longer true by the time the trading losses surfaced, but the MoF had not fully adjusted to the new reality. Indeed, within the Ministry, blame was placed squarely on Daiwa for not alerting the Banking Bureau to the implica­ tions of any delay in reporting the trading losses to the Federal Reserve. Neither Fujita nor anyone else at Daiwa had informed Nishimura about the consequences of the change in regulatory oversight. Nor were the sensitivities of U.S. regulators something obvious to the head

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of the Banking Bureau. With only modest banking experience and little aware­ ness of U.S. requirements, Nishimura was unaware of the need for increased sensitivity. The loss by Daiwa was therefore handled the way it would have been handled in Japan, rather than in the United States. In the new environment, however, the approach was no longer adequate; U.S. regulatory sensibilities now had to be considered. The scandal taught MoF officials that overlooking the U.S. could result in an embarrassing fiasco. In those circumstances, relying on the conventional, even traditional, bureaucratic response would not do, at least where foreign concerns were paramount. Formal or informal, discovery of large-scale financial impro­ prieties could not simply be ignored but required affirmative steps. The MoF could not, therefore, rely on the unofficial nature of the communication as an excuse for failing to report the matter to U.S. regulators. The lessons learned could be seen when similar behavior surfaced again. The Long Term Credit Bank (LTCB) discovered in March 1996 that it had unre­ ported trading losses. The LTCB immediately notified banking regulators in the U.S. and began an internal investigation. Only then was the MoF informed. The LTCB agreed to pay the Banking Department in New York a $1 million fine and change its internal practices, a far less severe penalty than the one imposed on Daiwa. The most important implication of the Daiwa matter, however, was often lost in the recriminations over the debacle. This involved the unmistakable role of standard bureaucratic practices in handling the trading loss. The event showed both the consequences of rapid rotation and the problems associated with reli­ ance on informal communications to convey critical developments. In most ways, Nishimura was a product of a typical bureaucratic career. He had undergone the usual Ministry practice of rotating in and out of various offices. Most of his career had been spent in the Budget Bureau and included a tour in the Economic Planning Agency. His appointment as deputy director general of the Banking Bureau was his first significant introduction to the fi­ nancial industry. As a result, he lacked substantive banking expertise and ex­ perience in dealing with foreign regulators. Had someone with greater exposure to financial matters headed the bureau, the implications of nondisclosure might well have been apparent. The scandal also illustrated problems with the informal method of commu­ nicating between banks and the Banking Bureau. Most relations with the MoF were informal. Rather than wait for some type of official report, bureaucrats preferred to be alerted informally of any impending problem. The method of communicating was common practice. Nor did informal disclosure suggest re­ duced significance. As those in the financial markets knew, the message was judged not by the method of disclosure but by its overall importance. Daiwa had unmistakably signaled the importance of the matter. The infor­ mation came through the highest-ranking channels. As any bureaucrat knew, bank presidents did not convey information directly to the head of a bureau

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unless it involved a matter of considerable importance. Less important issues could be handled at lower levels through the MoFTan. Daiwa fulfilled its obligation to report, thereby avoiding the bureaucratic pro­ scription against surprises. At the same time, however, it was left to its own devices to solve the problem, which is what it wanted. The bank knew that if it made a more “ formal” report to the MoF, the Ministry would have no choice but to take steps to ensure adequate resolution. Daiwa, however, wanted to delay disclosure of the development to the public. It would be factored into the mid­ year earnings and make the bank look weaker relative to the other financial institutions. Both regulator and regulated, therefore, benefited from the informal process. The only real losers, but for the anger of the Federal Reserve Board, were those dependent upon the efficacy of the disclosure process, particularly investors and depositors. In Japan, however, the former had little importance and the latter were to be protected through the traditional approach of secrecy and MoFmanaged solutions. The consequences of inaccurate disclosure in a transformed economy were growing. No one fully trusted the disclosures by banks and securities firms. Nor was the Daiwa Bank scandal the only illustration of the problem. Inaccurate financial statements seemed endemic. When Nikko’s U.S. subsidiary lost $18 million in foreign exchange trading, management reported the loss, but did so over a period of months, obscuring the true impact.8 Nikko could claim that it disclosed the matter but did so in a way that minimized the harm. The fact that the approach also involved inaccurate reports filed with the U.S. Securities and Exchange Commission was apparently of little moment. During the banking crisis of the 1990s, banks and securities companies pur­ portedly disclosed the full extent of their bad loans, only to be forced later to dramatically increase the amounts. Banks that seemed healthy one day would suddenly fail the next, with bad loans equaling not the 10% previously disclosed, but approaching something closer to 50%. Hyogo Bank had shown in its last financial statements prior to collapsing that only 2.2% of all loans were non­ performing. When it failed five months later, the true percentage was closer to 25%. When Yamaichi collapsed, investigators found billions of dollars of un­ reported losses. In fact, rumors had been rampant in the financial markets about the weak state of two large banks, Nippon Credit and Hokkaido Takushoku, at least since the early 1990s. Yet their poor condition was not officially acknowledged or decisive steps taken until 1997. Similarly, a handful of other trust, long term credit and regional banks were believed to be in dire straits, despite relatively healthy balance sheets. Excuses that permitted delays in disclosure were tolerated by regulators. Bu­ reaucrats had little incentive to deal with crises and did not aggressively press for more accurate and cataclysmic financial data. It amounted to a deep-rooted culture of concealment, at least where sufficient grey areas existed to permit the

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practice and where disclosure would be harmful to the financial system. Both regulator and regulated implicitly understood and agreed to the approach. It would stretch the truth to contend that the Banking Bureau tolerated know­ ingly false financial statements. The problem was the lack of rigor applied in drafting the statements. Given the personal nature of the relationship, the MoF had never imposed high levels of precision on financial reports. Indeed, it was probable that the banks themselves did not know their precise financial condi­ tion, never having adopted systems designed to ensure rigorous accumulation of financial data. The tolerance of inaccurate reporting had at least three significant, negative implications. First, it damaged the integrity of the entire financial system. The public knew that the numbers did not reflect the true state of affairs. The un­ certainty increased the sense of crisis in the financial markets, with no one knowing which bank had underreported bad loans and would fail next. The uncertainty also imposed costs by penalizing healthy banks, since even their financial statements were viewed with suspicion. Moreover, it contributed to the sense that things were out of control. When­ ever the Banking Bureau made statements about the crisis coming to an end, they were treated with the same level of credibility as the reports themselves: not much. Bureaucrats would state that the worst was over, only to have another failure inevitably surface shortly thereafter. Leaked information about the prob­ lems of Cosmo Credit caused a panic, with the public having lost faith in the MoF’s ability to handle the crisis. No sooner had officials announced that the top 20 banks would never fail than Hokkaido Takushoku collapsed. Second, the absence of rigor meant that banks had not felt it necessary to put in place strict systems designed to ensure the accuracy of the reported infor­ mation. The result was inadequate monitoring systems within the financial in­ stitutions themselves. While the Banking Bureau may have mishandled Daiwa’s trading loss problem, the matter never would have occurred had Daiwa had a better system for detecting trading irregularities. The system at Daiwa’s New York branch was unrigorous and allowed Iguchi to hide his trading losses for 12 years. Finally, the approach was premised upon voluntary disclosure of serious prob­ lems. As the Banking Bureau learned, however, life-threatening problems within a bank or securities firm instilled in management a powerful will to survive, even if it resulted in inaccurate financial reports or non-disclosure to regulators. In some cases, therefore, bank officials would deliberately hide their financial problems from the MoF. In other cases, they had considerable incentive not to investigate too closely and trigger a disclosure obligation. Either way, bureau­ crats were kept in the dark and not able to perform their traditional supervisory function. While personal oversight was not inherently improper, it did pose risks. The approach could be used as an advance warning system, alerting bureaucrats to upcoming issues. It could not, however, be treated as a substitute for accurate

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reporting. Yet accurate reporting would also have consequences, making the public aware of the problems sooner and forcing on the Ministry the need for more rapid intervention. Accurate reporting, therefore, would require consider­ able change in the relationship between regulator and regulated.

CHAPTER 9

L esso n s L earned: Secrecy an d th e B ailout of th e Jusen

To a large degree, the 1990s represented a decade of transition. The compart­ mentalized financial system was finished; interest rates were deregulated; bank failures had occurred. While the Banking and Securities Bureaus tried to control the pace of deregulation to give weaker participants time to adjust, it seemed clear that Japan’s financial system would soon be fundamentally reconfigured. Despite (or perhaps because of) its impressive ability to manage regulatory reform and financial crises, the Ministry of Finance initially saw little reason to change its approach toward financial oversight. A critical part of the approach was the reliance on secrecy. The practice was to withhold from the public the true state of affairs. Solutions were devised in a black box. Bureaucrats would operate behind the scenes, with the problem and solution usually announced simultaneously. The public would be unaware of the crisis and the Ministry’s efforts. The approach was viewed as necessary to avert any destabilizing panic. In an era of occasional problems and straightforward solutions, the approach functioned well enough. Japan in the 1990s, however, confronted a constant stream of crises, each one more serious than the last. Solutions were harder to devise. Matters would leak to the press before resolution, often creating a sense of panic among investors or depositors. Secrecy was becoming counterproductive, a symbol of indecision and myopia. Each time officials from the financial bureaus announced that the worst was over, another disaster surfaced. Ministry credibility plummeted. Continued ability of the financial bureaus to function in the end depended upon their capacity to retain public confidence. Excessive secrecy, lavish enter­ tainment and overtly anti-consumer policies had tarnished the MoF’s image. Regaining confidence would require a concerted effort and considerable change in bureaucratic practices. Greater openness was one way to begin the process.

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This was not lost on the bureaucracy. The need for a more open approach gradually became apparent. To understand the actions of the MoF, however, was to understand the education of the chief banking regulator, Yoshimasa Nishimura. Nishimura had little experience with banking, having spent most of his career in the Budget Bureau. When placed in charge of banking, he had every reason to expect a quiet, two- or three-year reign, possible elevation to admin­ istrative vice minister, and retirement to a lucrative position in the private sector. His time in office, however, was marred by continual crisis. It was during his watch that the first run on a bank in the postwar era occurred; that the first bank failed; and that the disastrous $1.1 billion in trading losses by Daiwa Bank became public. The developments caused Nishimura to realize that the traditional ways had to change, most noticeably in reduced reliance on secrecy. Ironically, the new approach surfaced most obviously in connection with the incident that proved the most controversial, the bailout of the jusen or housing loan companies. The jusen had engaged in a speculative lending binge and, in the fifth year of the slowdown, were beyond salvation. Despite knowledge of the problems, officials in the Banking Bureau preferred incremental steps over decisive action. By 1995, the jusen epitomized a financial system that chose to keep even the sickest financial institutions alive rather than accept a failure. It was Nishimura more than anyone in the MoF who realized the harm to the financial system from maintaining financial institutions that had no hope of recovery. He was the one who allowed the first bank in the post-occupation era to fail. He would take the same approach with the jusen. As part of the liquidation process, Nishimura became the first to request public funds. In some respects, he had no choice. Although banks and other financial institutions would contribute, they refused to pay the entire cost. Using public funds caused enormous controversy. As the subsequent failure of Yamaichi Se­ curities Company and Hokkaido Takushoku would show, however, Nishimura’s judgement not only was right but, if anything, was far too modest in the amount requested. Nishimura knew that convincing the public and reigning politicians would require a substantially altered approach. The traditional black box method of resolving matters through secrecy and backroom negotiations would not work. Instead, in an uncharacteristically open approach, the public would receive full disclosure. They learned about the true extent of the problems confronted by the jusen and the identities of the borrowers who reneged on their loans. Former high-ranking bureaucrats testified before the Diet, with Nishimura having leaked information about deals between the MoF and the Ministry of Agriculture. The tectonic shifts in bureaucratic behavior were generally lost in the maelstrom that descended on the Banking Bureau for calling for the use of public funds. The irony was that the use of public funds had a political rather than bureau­ cratic explanation. Had the Banking Bureau been able to handle the crisis as it had wanted, the funds probably would have been unnecessary. Politicians, how­

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ever, intervened and prevented the bureau from forcing farm banks, the finan­ ciers of the jusen, to pay their fair share of the rescue operation despite their complicity. Politicians also emerged from the crisis unscathed, with most of the blame placed on the shoulders of the MoF. The controversy illustrated that in a transformed economy, it was not only the bureaucracy that needed to change. Although the use of public funds had a political explanation, the Japanese press spent most of its time excoriating the bureaucracy rather than holding politicians accountable. As Japan changed, the press would have to learn that with increased openness came increased respon­ sibility.

THE IMPETUS The most prominent financial debacle to tar the MoF was, ironically, not really the Ministry’s fault. It involved the use of public funds to bail out the housing loan companies or jusen, specialized companies that offered propertyrelated loans and mortgages. Set up in the 1970s, the jusen were created at the insistence of the MoF to fill a gap in the financial system. With growing affluence, individuals clamored for loans to purchase homes. Commercial banks were still lending primarily to industry and were not in a position to take advantage of the growing demand for mortgages. With the encouragement of the Banking Bureau, they created the jusen, a class of financial institutions specifically designed to meet the burgeon­ ing mortgage market. Nippon Housing Loan Company became the first, with seven jusen in existence by 1978. Initial funding came from the large commercial banks, although securities firms and insurance companies also participated. Colloquially known as “ mother banks,” the founding financial institutions retained close relations with the jusen they sponsored. The banks lent them funds and sent them business. They were largely run by former employees of the mother bank, although they also rep­ resented a popular landing pad for retiring MoF officials. As corporate lending declined, commercial banks began to enter the market directly. The jusen suddenly found themselves with considerable competition. Between 1980 and 1990, commercial banks largely pushed the jusen out of the residential mortgage business. In response, the housing loan companies increas­ ingly engaged in higher-risk lending, particularly to real estate speculators. Territorial disputes within the bureaucracy left the Banking Bureau unable to do much about the speculative lending binge of the jusen. In general, nonbank financial institutions were subject to oversight not by the MoF but by MITI. While the MoF had some authority over the jusen, it included only limited inspection powers. When officials at the Banking Bureau wanted to examine housing loan companies in the early 1990s, they had to ask their permission. Moreover, some resisted. Keiichiro Niwayama, the president of Nippon Housing

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(and a former MoF official) refused until Masaaki Tsuchida, the director general of the bureau, intervened and asked him personally. The lack of authority over nonbanks largely tied the bureau’s hands. In an effort to reduce their speculative lending, bureaucrats were reduced to indirect means. Tsuchida, the head of the Banking Bureau, issued guidelines in March 1990 ordering commercial banks to restrict real estate lending. The guidelines did not apply to the jusen or other nonbanks. Commercial banks, however, were forced to reduce their lending to the jusen, cutting off the principal source of funds for the housing loan companies. By eliminating their primary source of funds, Tsuchida no doubt thought that he had put an end to the speculative lending binge by the jusen. He did not, however, account for the resourcefulness of the housing loan companies and their ability to find a source of funds beyond the MoF’s control. THE AGRICULTURAL COOPERATIVES The answer was to be the regional agricultural cooperatives. First formed during the occupation, agricultural cooperatives were designed to service the needs of farmers. A postwar source of capital for the rural areas, they lent primarily to their rural members, although they could also make loans to non­ members within certain limits. The 2,400 cooperatives also performed a number of other functions, including the marketing of agricultural products and the pur­ chase of farm equipment. In general, the agricultural cooperatives had a surplus of funds and deposited most of it with the 47 regional agricultural cooperative credit federations. Es­ tablished under the Agricultural Cooperative Law, each prefecture had a regional cooperative. They accepted deposits and lent to members. Their excess funds were generally deposited with the Norinchukin Bank, the central bank for the agricultural cooperatives. The Banking Bureau had limited authority over these financial institutions. Officials could and did inspect the Norinchukin Bank. The regional agricultural cooperatives, however, were another story. They were subject to the joint over­ sight of the Banking Bureau in the MoF and the Economic Affairs Bureau within the Ministry of Agriculture, Forestry and Fisheries.1 As a practical matter, the Ministry of Agriculture had primary responsibility. The division in authority would be a central cause of the crisis that followed. In the early days, farm banks were simply another type of financial institution designed to collect small deposits, aggregate them, and make them available for the capital needs of larger enterprises. As with the Postal Savings System, ag­ ricultural cooperatives also insured that financial institutions existed even in the most remote rural areas. Farmers would always have a place to go to deposit funds and get loans. With the end of the postwar capital shortage and the growing availability of credit, however, the farm banks became financial institutions in search of a

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purpose. As farmers became more affluent, deposits in the agricultural banks grew, eventually exceeding those for the city banks. At the same time, farmers were declining in number and borrowing less. The agricultural cooperatives, therefore, had plenty of funds but little to do with them. They could not engage in traditional commercial banking activities. Anti­ quated regulations prevented the farm banks from diversifying their business. No more than 20% of their total outstanding loans could be to non-members. With their postwar market disappearing, they were having trouble finding uses for their funds. The jusen provided a solution. Regional agricultural cooperatives received permission to lend to the jusen beyond the normal limits. Both the Banking Bureau and Economic Affairs Bu­ reau in the Ministry of Agriculture agreed in 1980 that the farm banks could treat the jusen as financial institutions not subject to ceilings on lending. The agreement also specified, however, that the loans would only be made to facil­ itate the purchase of real estate. Despite the greater latitude, lending by the farm banks to the jusen initially remained modest. That changed when Ministry guidance issued in 1990 forced the commercial banks to reduce their funding levels to the housing loan com­ panies. With the guidelines not including the regional agricultural cooperatives, they could and did lend to the jusen with abandon. The numbers told the story. Lending by the agricultural cooperatives went up 50% between 1989 and 1990 and increased another 33% the following year. By the time the jusen were scheduled for liquidation, total lending had jumped to ¥5.5 trillion. The single largest lender to the housing loan companies was the Norinchukin Bank. Had Tsuchida included the agricultural cooperatives in the guidelines he is­ sued in 1990, the jusen would probably have been unable to find the funds to pay for the lending binge that followed. The failure to include farm banks had a bureaucratic explanation. With the cooperatives subject to the oversight of the Ministry of Agriculture, efforts to subject them to the guidance would have generated an inter-bureaucratic struggle. Bureaucrats in the Ministry of Agri­ culture typically resisted MoF efforts to influence the financial institutions they controlled. As would become very clear, agricultural cooperatives were also well con­ nected politically. With the LDP particularly dependent on rural voters, farm banks were an important, protected institution. Tsuchida knew that an attempt to subject the agricultural cooperatives to MoF guidance would invite political inquiries if not intervention. In addition, reducing the lending of these financial institutions would have created another problem. It would have forced the cash-rich regional coopera­ tives to find another place for their funds, a significant bureaucratic headache. The reality was that the farm banks had outlived their usefulness. This would become apparent as the jusen crisis developed.

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BLAME The decline in fortunes of the jusen coincided with the collapse of the bubble economy. The economic slowdown in the early 1990s caused the speculative property boom to come to an end. Real estate prices plunged and loans became nonperforming in large numbers. With the loans made by the jusen largely collateralized by real estate, they suffered disproportionately. By 1997, up to 75% of total jusen loans were non-performing. There was plenty of blame to go around for the jusen disaster. In a broad sense, the segmented banking system was at fault. Whole classes of financial institutions, including the jusen and the agricultural cooperatives, had been set up at a time when competitive credit markets did not exist. Specialized financial institutions were used as a means of directing funds to specific segments of the economy. They now found themselves with undiver­ sified loan portfolios that reflected their earlier, now obsolete roles and made them particularly vulnerable to downturns in the economy. Had reform of the financial system arrived earlier, these entities either would have converted to ordinary commercial banks or disappeared. Their continued existence and higher risk now became a significant headache. The Banking Bureau was also entitled to some of the blame. The bureau had the foresight to restrict real estate lending by banks in 1990, which in the short term probably made things worse by contributing to the collapse of the property market. More importantly, in trying to cool off the property market, the Banking Bureau largely ignored the lending of the jusen. With other sources of lending disappearing, speculators besieged the housing loan companies. MoF guidance, therefore, reduced real estate lending by commercial banks but otherwise did not put an end to property speculation. Lending practices at the jusen also contributed. Loans were made to property speculators with little apparent analysis of the financial worthiness of the pro­ jects. The days when the companies enforced strict standards on individuals seeking mortgages were over. For property speculators, the floodgates seemed to be open. Commercial banks had a major role in the debacle. They were told to reduce lending in the real estate market. While adhering to the strict letter of the guide­ lines, they avoided the intent. Banks sent clients seeking property-related loans to the jusen they controlled. The result was not a reduction in overall lending, just a shifting of the responsibility to other institutions. The real culprits, however, were the regional agricultural cooperatives and their political allies. Farm banks were not included in the Banking Bureau’s guidelines restricting property-related loans. With another ministry having pri­ mary oversight, the MoF only had limited room to control their behavior. Farm banks did report lending activity to the Banking Bureau, but in a general way. The Ministry of Agriculture could have exercised greater control over the lend­ ing behavior of the rural financial institutions but did not. When the collapse of

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the jusen finally arrived, farm banks were overexposed, having become the larg­ est lenders to the jusen. Politicians also had a role in the process. The LDP had, on a number of occasions, interceded on behalf of interest groups and blocked financial reforms sought by the Banking Bureau. The Bureau had proposed the imposition of stricter reporting requirements for bank loans when revising the Banking Law in the early 1980s, something that would have alerted MoF bureaucrats sooner to problems in the financial system. In the amendments eventually adopted, however, the LDP deleted the requirements following protests from banks.2 A decade later, Banking Bureau bureaucrats tried to get increased authority to supervise nonbank financial institutions such as the jusen. Tsuchida’s initia­ tive, however, fell on deaf ears. The LDP declined to enact reforms when MITI and other ministries responsible for the oversight of nonbanks objected. The result was that the Banking Bureau entered the 1990s with inadequate inspection authority over the jusen, little control over the regional agricultural cooperatives, and minimal information about the lending practices of these financial institu­ tions. Political intervention would play a prominent role in the efforts to liquidate the jusen. Members of the LDP intervened on behalf of the agricultural coop­ eratives and stood poised to block efforts by the Banking Bureau to make them pay a greater share. Efforts to force farm banks to make a significant contribution to a rescue operation for the jusen, therefore, became impossible. In particular, Taichiro Okawara, a former Minister of Agriculture, and Koichi Kato, the Sec­ retary General of the LDP, were reputed to have been influential in the efforts to protect the cooperatives, although all top officials in the party had close connections to the agricultural community. RESCUE An earlier, more decisive approach in the Banking Bureau might have re­ solved the jusen problem sooner. As the decade opened, however, the bureau was still steeped in the traditional way of doing things. Tsuchida, the director general, had spent much of his career in the bureau, including the Research Division (responsible for legislation) and the Commercial Banks Division (re­ sponsible for the largest banks). While experienced and pragmatic, he favored the usual approach of forbearance, secrecy and incremental change. This could be seen in connection with the early handling of the jusen. The problems with the housing loan companies were well known within the bureau, although the extent was underestimated. Banking Bureau inspectors had exam­ ined the housing loan companies in 1991 and 1992. It became increasingly apparent to those within the bureau that something had to be done. Both Tsuchida and his successor, Nobuyuki Teramura, employed traditional methods to solve the crisis. The jusen would not be allowed to fail, with for­ bearance the controlling philosophy. They would gradually be nursed back to

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health, mostly by contributions from their principal lenders. The approach relied on secrecy and cooperation from the private sector, and avoided the need for public funds. This was the way every bailout in the post-occupation period had been structured and neither Tsuchida nor Teramura saw any reason to do things differently. This time the approach developed unexpected complications. The mother banks could be induced to contribute. They would forego interest payments and write-off loans. The regional agricultural cooperatives were, however, another story. Not subject to exclusive control of the Banking Bureau, they could turn to their allies in the Ministry of Agriculture and the Diet for support. Any effort to pressure them into contributing to the rescue would require inter-ministry negotiations, never an easy matter. Farm banks could and would resolutely refuse to take any significant blame for the failure of the housing loan companies. Some of the regional agricultural cooperatives also accurately contended that they could not survive if they had to pay their fair share. Mostly, though, they knew that, whatever their culpabil­ ity, their supporters in the LDP would protect them. Thus they would make only modest financial contributions to any rescue operation. From the very beginning, therefore, the farm banks received favored treatment in the efforts to solve the jusen crisis. The Banking Bureau’s initial plan sought to nurse the jusen back to health over a 10-year period. As part of the proposal, commercial banks agreed to forego interest payments on loans extended to the companies. In contrast, the agricultural cooperatives merely reduced their inter­ est rates from 6.5% to 4.5%. Even this minor concession was not easy to extract. As part of the negotia­ tions, the head of the Banking Bureau, Nobuyuki Teramura, wrote a letter to his counterpart in the Bureau of Economic Affairs in the Agriculture Ministry, Takenori Manabe, stating that the founding commercial banks would “ take re­ sponsibility” for the jusen problem and would not place added burden on the cooperatives. The note amounted to a guarantee that, in any rescue operation, the agricultural cooperatives would not have to forego their loans to the housing loan companies. In hindsight, the note was a mistake. It provided the agricultural cooperatives with a firm basis for refusing to make any significant concessions. At the time, however, Teramura did not know the full extent of the problem. He also did not want the regional agricultural cooperatives to cause a more serious crisis by demanding repayment of their loans, throwing the jusen into immediate insol­ vency. The concession in the note, therefore, seemed a small price to pay to obtain the cooperation of the Ministry of Agriculture and avoid a destabilizing crisis. As the economic slowdown continued and the extent of the problem became clearer, the limited plan had to be abandoned in favor of something more im­ mediate and costly..The continuing crisis was damaging international confidence in the financial system, with Japanese banks paying a huge risk premium in

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international markets, at one juncture climbing to an entire point. The problems of the jusen were severe and could not await a comprehensive solution for the entire financial system. It was Nishimura, the director general of the Banking Bureau, who decided that the matter could no longer be allowed to fester. Having become increasingly aware of the extent of the problems confronting the financial system, he refused to adhere to the bankrupt policy of forbearance, at least with respect to the jusen. Instead, they would be liquidated. The only question was how to pay for it, with contributions by the regional agricultural cooperatives the most difficult issue. Ordinarily, the matter would have been resolved through negotiations between bureaucrats in the Banking Bureau and the Norinchukin Bank as the industry representative. The issue, however, had become too political. Instead, talks had to take place directly between officials in the Finance Ministry and bureaucrats in the Ministry of Agriculture. Powerful politicians in the Diet would receive reports on the progress of the negotiations. Responsibility for negotiating the agreement ordinarily fell to a director (kacho) of the division within the MoF charged with oversight of nonbanks. The director general of the Economic Affairs Bureau, Hidetaka Tsutsumi, however, refused to allow the comparable division director in the Ministry of Agriculture to conduct the negotiations, making these lower-level efforts fruitless. As a re­ sult, Nishimura had to intervene and negotiate with Tsutsumi directly. The ef­ forts, however, proved unavailing. With farm banks largely refusing to participate, the use of public funds was becoming increasingly inevitable. Nishimura knew that any such proposal would be controversial, infuriating politicians and the electorate. He also knew that it would generate opposition within the Ministry itself. The entire top echelon of the Ministry— the vice minister, the director general of the Budget Bureau and the head of the Secretariat— opposed the plan. They had little interest in an incendiary proposal that would further damage relations with powerful politicians in the LDP. Officials in the party were still angry at the MoF’s willingness to work with the Hosokawa government. A politically sensitive, publicly unpopular proposal emanating from the Banking Bureau would only make relations worse. With the negotiations between the two ministries not going well, the head of the Secretariat, Yoji Wakui, a future head of the Budget Bureau and candidate for administrative vice minister, took over. He was on good terms with bureau­ crats in the Ministry of Agriculture and, as a member of the Saito family, per­ haps the most influential bureaucrat within the MoF. Unhappy with the lack of progress, he engaged in direct negotiations with Hirofumi Ueno, the vice min­ ister in the Agricultural Ministry. His efforts, however, did not succeed. The fault may have been Wakui’s. He overestimated the strength of his contacts. He also committed a bureaucratic slight by dealing with the vice minister instead of the director general of the

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Economic Affairs Bureau, the person in the Ministry of Agriculture directly responsible for the matter. In reality, however, no effort was likely to succeed. Bureaucrats in the Min­ istry of Agriculture had no reason to be more cooperative. The regional agri­ cultural cooperatives continued to disclaim fault and refused to pay their fair share of the bailout. In the end, the farm banks agreed to contribute only ¥530 billion, while insisting that their loans of more than ¥5 trillion be repaid in full. When the negotiations failed to elicit a greater contribution, the problem reached crisis proportions. The extent of the financial problems of the jusen had been made public. The status quo was not acceptable. Some type of proposal for public funds was now inevitable. Once the decision was made to seek public funds, opposition within the MoF receded. All bureaus united to support the effort, with the International Finance Bureau given responsibility for the foreign press. Moreover, with pressure build­ ing on Nishimura to take responsibility and resign from the MoF, rumors in­ dicated that Shinozawa, the vice minister, stepped down to deflect those efforts, a remarkable display of self-sacrifice, particularly given his initial opposition to the plan. Nishimura himself would resign a few weeks before his term expired, in atonement for the crisis.

OPENNESS The merits seemed to favor the use of public funds. Indeed, in one sense, the decision suffered from a lack of ambition. The jusen represented only one of many problems confronting the markets and only one of a number of outmoded classes of financial institutions facing insolvency. Public funds could be nec­ essary in other circumstances, as subsequent developments would indicate. In resolving the matter, the traditional approach had been to negotiate with the top officials of the LDP and come to an agreement. This time, however, bureaucrats would use a different approach. The need for public funds would become a matter of public debate. The process would be open, with all Ministry data disclosed. Decisions would be made in a fishbowl. Nishimura’s decision to open the process in part resulted from altered political dynamics. After the LDP returned to power, the old ways no longer worked. For one thing, the rank and file expected to have some say in the matter. For another, the LDP was part of a coalition. The views of Sakigake and the So­ cialists had to be taken into account. Mostly, though, Nishimura had learned that secret and backroom negotiations had become counterproductive. His epiphany arose from the efforts to rescue Tokyo Kyowa and Anzen Credit. Although collapsing in 1994, their problems had been known to financial regulators for at least two years. For the first time, no bailout could be arranged. The losses of the two financial institutions ex­ ceeded what the Deposit Insurance Corporation was legally allowed to pay to

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any rescuing bank. Without sufficient financial support, no private bank was willing to acquire their assets. Nishimura and his counterparts in the central bank secretly devised a complex scheme. Assets would be transferred to a new financial institution, with the entity capitalized by contributions from the Bank of Japan and a large number of financial institutions. In many respects, however, Nishimura handled the matter in the traditional fashion. Matters were kept secret from the public. The Banking Bureau declined to disclose the identity of the principal borrowers from the failing financial institutions. Moreover, when the bureau ultimately revealed their names to the Diet, it was with the condition that the confidentiality of the information should be maintained. The proposal also coincided with scandals within the MoF suggesting that bureaucrats had accepted favors from speculators who had borrowed consider­ able sums from the two failed financial institutions. The combination of secrecy and scandal created a sense of favoritism and unfairness. Rather than be lauded for solving a difficult and complex problem, therefore, Nishimura found himself at the center of controversy, the subject of sharp criticism. The experience with Anzen Credit and Tokyo Kyowa had a sobering effect on Nishimura. Nishimura would have no repetition of the prior experience. When he confronted the problem of the jusen he would institute a plan that gave the public much greater access to, and participation in, the debate. This time the identity of the borrowers would be revealed. Data on the true extent of the bad loan problem for the jusen would be disclosed. Bureaucrats would testify at the Diet and explain their policy decisions. Secret bargains among ministries would be revealed. There were limits, however. While Nishimura could educate the public about the extent of the problem, he could not point the finger directly at those re­ sponsible for the public funding, particularly politicians. They had adamantly refused to allow the Banking Bureau to exact a larger contribution from the regional agricultural cooperatives. Nor could he remind the public that the LDP had caved in to pressure and refused to adopt Ministry-supported requirements for better financial disclosure and increased inspection authority over the jusen. The greater openness notwithstanding, suggestions that public funds be used in a bailout generated a political revolt. Ironically, the Socialists and Sakigake, the two coalition partners, were the strongest proponents of the Banking Bu­ reau’s efforts. Takemura, then the Finance Minister, reluctantly became a sup­ porter. The top rung of the LDP also gradually accepted the need for public financing. Hashimoto, for one, grudgingly supported the proposal. So did the party’s kingmaker, Takeshita. Instead, primary opposition came from the rank and file of the LDP. Some of the opposition was on the merits, although increasingly politicians recognized that public funds would be needed to rescue the failing financial institutions. In some cases, the opposition was more personal. LDP politicians were still angry because they had been ignored by bureaucrats during their brief period out of

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power. Others would not support any proposal put forth by Takemura, an un­ popular figure within some segments of the LDP. Politicians also resented having to consider another controversy so soon after having approved an in­ crease in the consumption tax, an unpopular, MoF-inspired initiative. Most importantly, however, the rank and file were the ones who would have to pay the price of a sharply unpopular program with the electorate. They were not going to take the blame for the crisis. They wanted to deflect responsibility, with the MoF an obvious candidate. Convincing the rank and file took an unprecedented level of bureaucratic time and effort. Top-level officials in the Banking Bureau had to traipse over to the Diet and have one-on-one meetings with LDP politicians. They also endured public hearings and open criticism in the Diet. As was traditional, the matter of public funds was first referred to the Finan­ cial System Research Council, an advisory body connected to the Banking Bu­ reau. Staffed by a cross-section of the financial system, including retired bureaucrats from the Ministries of Finance and Agriculture, the Council had a reputation for rubber-stamping proposals proposed by the bureau. Indeed, the chairman was Satoshi Sumita, a retired vice minister and former governor of the Bank of Japan. In approaching the matter, bureaucrats usually had predetermined conclusions, with the Council at best making modest refinements. A final report issued by the Council, while circulated to the participants, was inevitably written by a bureaucrat from the Banking Bureau. MoF officials controlled the agenda and the flow of information to the Council. This changed in connection with the jusen bailout. For one thing, the Council members deliberating over the issue were more independent. The discussions took place within the Financial System Stabilization Committee, a subgroup of the Council. Although some retired bureaucrats attended the meeting (including Satoshi Sumita, Tsuchida, the former director general of the Banking Bureau, and Kenichi Kakudo, a retired vice minister of the Ministry of Agriculture and president of Norinchukin Bank), the chairman was Ryuichiro Tachi, a professor from the University of Tokyo. Close to bureaucrats in the MoF, Tachi had the stature and influence to enable him to take positions independent of the Banking Bureau. Other members of the Stabilization Committee were likewise independent, a deliberate decision by Nishimura to insure real deliberations. There would be no automatic acceptance of bureaucratic proposals by this group. The Banking Bureau also did not arrive with predetermined conclusions and did not exercise its traditional control over information. In an unprecedented fashion, the Stabilization Committee received complete disclosure. The Com­ mittee obtained sensitive data about the status of the financial system. When the bureau updated statistics on the quantity of bad loans, the information went to the Committee. Most significantly, bureaucrats in the Banking Bureau disclosed the inspection

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results of the jusen. Revealing the enormous number of bad loans held by the housing loan companies was unusual. Considered exceedingly confidential, that type of information in the past had been withheld. Aware that it could leak to the public, the bureau historically feared that disclosure would damage confi­ dence in the financial system. This time, however, the information was released and disclosed to the public. Disclosure involved a calculated risk. While the data made clear the full extent of the problems confronted by the jusen, it also meant that anything short of a complete solution would be unacceptable. This made the use of public funds that much more inevitable. Another sharp break concerned public access to the deliberations. The press did not attend the meetings nor did it have representatives on the Stabilization Committee. Nonetheless, a press briefing followed each meeting. The general nature and progress of the deliberations were disclosed, although the identity of particular proponents was kept confidential. Information given by the Banking Bureau to the Stabilization Committee was immediately passed on to the press. If the Committee knew the extent of the bad loan problems, so did the public. The approach allowed an unparalleled degree of public insight into the Com­ mittee’s deliberations. The Council issued two reports, both startling in their bluntness. One in Sep­ tember 1995 stated that failing financial institutions should not be allowed to continue operating. As for public funds, the Council indicated that they may be required in the event of an “ imminent threat” to the financial system. The noncommittal nature had a specific explanation. Negotiations between the MoF and the Ministry of Agriculture were still taking place. Until these were finished, the need for, or extent of, public funds was unknown. The second report, in December of the same year, recommended the use of public funds, specifically ¥685 billion (or more than $6 billion) to provide as­ sistance in bailing out the jusen. The report called the need for public funds “ unavoidable” but also criticized the government for inadequate supervision. Opposition to the proposals surfaced immediately, with criticism reaching a feverish pitch. With popular opinion overwhelmingly against the use of public funds, the proposal became a divisive political issue. Shinshinto (the New Fron­ tier Party) alleged that LDP politicians had received campaign contributions from agricultural cooperatives and from jusen borrowers. Opposition parties staged a sit-in at the Diet building and blocked legislative action for several months. Politicians demanded public hearings. On this, all of the parties in the Diet agreed. The hearings were held in February 1996. They amounted to a public spectacle, with more than 40 witnesses testifying. In an unprecedented fashion, two former directors general of the Banking Bureau participated and were forced to explain their decisions concerning the jusen. In particular, Teramura had to justify the note he executed with his counterpart in the Ministry of Agriculture, a secret agreement that had been disclosed by the Banking Bureau.

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All of this meant that the public received an unprecedented level of infor­ mation. Nonetheless, the hearings degenerated into an attempt by politicians to assign responsibility for the fiasco, with bureaucrats catching much of the blame. The two groups not subjected to the withering criticism were those that were the most responsible: politicians and farm banks. Little was made of the refusal of regional agricultural cooperatives to contribute more to the rescue. Politicians did not want to be seen criticizing the institutions at public hearings. Nor did political protection of the agricultural cooperatives receive any significant atten­ tion. Legislation on the bailout was ultimately adopted, with only small changes made to appease opposition parties. The Diet approved the financing in June 1996, providing a relatively modest ¥685 billion ($6.2 billion) in public funds to bail out the housing lenders. The legislation also created the Housing Loan Administration Cooperation and assigned to it the task of taking over the loans and attempting to recover as many as possible. The public contribution represented only a small portion of the total costs associated with the bailout. The regional agricultural cooperatives escaped largely unscathed. Their loans would be repaid. They only had to contribute ¥500 billion to the bailout, less than a tenth of the contribution of the other financial institutions. Commercial banks had to bear the heaviest portion of the total costs, both financially and psychologically. Banks were required to write off ¥5.2 trillion in loans and to hire many of the employees of the failed jusen at the very time they were trying to thin their own ranks. In the traditional Japanese fashion, a number of bank presidents were forced to resign over their role in the debacle. Politicians in particular insisted on “ atonement,” a not so subtle call for their resignations. The finance minister, Wataru Kubo, was the most insistent. Tadashi Ogawa, the administrative vice minister who took over following Shinozawa’s early resignation, met with a number of bank presidents and “ encouraged” them to take “ responsibility” for the crisis, a not so subtle demand that they resign. In the end, Yo Kurosawa, president of the IBJ, the largest commercial lender to the jusen, and Torn Hashimoto, the president of Fuji Bank and the former chairman of the Federation of Bankers Association, resigned, although they denied they did so in response to the jusen scandal. Having instigated the bailout proposal and been subjected to public and po­ litical criticism, Nishimura was made to play one final role in the matter. In an effort to defuse public criticism, politicians wanted commercial banks to con­ tribute to a separate pool of funds designed to repay the government for the costs of the bailout. Former Prime Minister Takeshita even met with officials from some of the largest banks to discuss the idea. Hostile toward any additional contribution, the banks refused. Desperate to create the fund, politicians insisted that Nishimura pressure the banks into contributing. Already blamed for the jusen bailout and criticized over the handling of the Daiwa Bank trading loss, he was now expected to antagonize

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commercial banks in an effort to shift blame away from politicians. In doing so, Nishimura’s actions violated accepted protocol between banks and bureau­ crats. Rather than begin the process with lower-level contacts, Nishimura met with the presidents of the big banks and invited them to participate in the fund, giving them two days to respond. The method effectively gave the banks no choice, something that further exacerbated tensions. Nishimura thereby fulfilled his obligation to the LDP, but at great personal cost, engendering anger and hostility from the contributing financial institutions. The bailout had passed; a financial crisis averted. Public funds were, for the first time, made available to help deal with the mounting insolvencies in the financial system. In many ways, it resembled a traditional MoF victory. The bureaucracy confronted the problem, devised a solution and gave it to the pol­ iticians, who then adopted it without significant amendment. Moreover, the Banking Bureau benefited from the bailout. With the jusen dissolved, an outdated class of institutions no longer needed in a competitive, decompartmentalized financial system had been eliminated. It may also have hastened the demise of the agricultural cooperatives, a group of financial insti­ tutions not subject to the exclusive oversight of the Banking Bureau. The bailout, therefore, contributed to the continued process of casting off the postwar finan­ cial system. In reality, however, the MoF suffered an enormous blow to its prestige, with its reputation all but permanently tarnished. Public blame for the controversy fell almost entirely on the bureaucracy. Demonstrators for the first time appeared outside the Ministry building, armed with sound trucks to announce their pres­ ence. The MoF now had to be protected from the public. Where there had once only been a sleepy policeman or two, suddenly real security measures had to be instituted. Public imagination seemed focused on dismembering the MoF, with all political parties putting forth proposals to do so. Proof of the public’s reaction and tendency to blame the bureaucracy surfaced quickly. In elections held in October 1996, only a few months after adoption of the jusen bailout legislation, the LDP emerged intact, little blamed for the bail­ out. Indeed, the party increased its size in the Diet. Moreover, those that had supported the bailout— Sakigake and the Socialists—suffered significant losses. LESSONS LEARNED Blame for the jusen was widespread. Financial institutions, politicians, reg­ ulators and the jusen themselves all failed to act decisively. The real source of the problem, however, was the compartmentalized financial institution. Both the jusen and the farm banks had outlived their usefulness. In a more competitive environment, specialized financial institutions designed to serve a particular seg­ ment of the market could not adequately diversify and posed greater risk. In a deregulated financial system, both categories would eventually disappear. The irony was that the Banking Bureau, more than any other organization,

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was committed to ending the compartmentalized financial system. The need for consensus and the ability of some segments of the financial system to appeal to their political allies interfered with the process. It was the agricultural cooper­ atives that slowed the pace of interest rate deregulation in the late 1980s. A more rapid pace of decompartmentalization would have solved the problems of the farm banks and jusen before they reached crisis proportions. The Banking Bureau may have erred in failing to act sooner. After all, the bureau knew by 1992 that the jusen were in bad shape, with even some com­ mercial banks calling for their liquidation. Under Nishimura, however, the bu­ reau acted decisively. It was the absence of authority over the farm banks and the protection afforded by politicians that turned the rescue operation into a public relations nightmare. Nonetheless, in the eyes of the public, the blame for the debacle rested squarely with the bureau. In part, this was consistent with the postwar under­ standing between politicians and bureaucrats. Although politicians influenced all developments and policy decisions, the myth was that significant reforms orig­ inated with the bureaucracy. As a result, bureaucrats received the accolades when things succeeded and the blame when they failed, shielding politicians. In the jusen context, the relationship meant that bureaucrats could not defend themselves when politicians assigned them the blame. Politicians wanted a scapegoat and the MoF was the most obvious choice. There was nothing unusual in this. Politicians had, in the past, often deflected blame from their own actions and instead claimed that responsibility rested with the bureaucracy. The irony was that the Banking Bureau’s handling of the matter was a sub­ stantial break from the past. More information was made available to the public. The identity of the principal borrowers was disclosed. The Stabilization Com­ mittee engaged in true deliberation. Rather than being lauded for the approach, however, Nishimura and the Banking Bureau were subjected to harsh criticism. The more open approach by the bureau did have benefits, although they were subtle. For all of the criticism of the bailout, the debate was not tinged with allegations of bureaucratic unfairness. Past financial crises had contributed to the impression among ordinary Japanese that the Ministry looked out for the best interests of well-connected land speculators or wealthy supporters of poli­ ticians. Those claims swirled around the rescue of Tokyo Kyowa. This time, no serious contention arose that secrecy was used to protect borrowers. The debate focused on the reasons why the crisis occurred in the first place. Nishimura’s reliance on openness doomed the black box approach of the MoF so prevalent in the postwar period. The public would expect, in the future, to be told the truth. Bureaucrats would learn that by disclosing the accurate state of affairs, greater appreciation would exist for the difficulties of the decisions confronted by MoF officials, reducing criticism. The crisis also demonstrated one other area that required a substantial change in behavior as the Japanese economy was transformed. Politicians and farm banks largely emerged unscathed because of the uncritical approach taken by

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the Japanese press. With attacks on the MoF in vogue, news reports had an easy time blaming bureaucrats. They did not conduct a critical analysis of the real reasons for the crisis. Nor did they investigate those politicians particularly responsible for protecting the farm banks, necessitating the need for public funds. With bureaucrats largely unable to protect themselves, politicians would continue to deflect away blame until the press declined to accept the ruse and made them more accountable.

CHAPTER 10

The B udget an d th e B ureaucracy

The Ministry of Finance’s international reputation came primarily from its man­ agement of the financial markets. The true power of the bureaucracy, however, flowed from the control over the budget. Other ministries knew that on an annual basis they had to go on bended knee and explain their funding needs to a deputy budget examiner at the MoF. Increases had to be justified, new programs ex­ plained. Moreover, officials in the Budget Bureau could simply say no, forcing the ministry to give up or appeal to politicians, neither approach completely acceptable. The MoF’s authority, however, came from more than its role in the annual budget process. The MoF also constituted a repository for information about each ministry. Every year, the MoF sent out a raft of bureaucrats to other min­ istries and agencies, giving them additional access to financial information. In particular, MoF officials assumed critical positions in the inspection agencies, government agencies that controlled personnel and structural issues within the bureaucracy and that conducted audits. The MoF, therefore, had a hand in any significant change to the bureaucracy. Attributing exclusive control over the budget to bureaucrats, however, ignored the intensely political nature of the process. Members of the Diet had consid­ erable influence over spending decisions. The constant but often subtle political influence meant that the Budget Bureau did not have the ability to impose its own subjective judgment on the merits of a particular ministry’s budget. In managing the budget process, the MoF confronted incessant demands for increased expenditures from two interrelated sources. Ministries themselves un­ relentingly sought extra funds, seeking to add new items to their budgets. Pol­ iticians also pul pressure on bureaucrats, particularly for projects related to their electoral districts. Whether a bullet train or a bridge, politicians viewed the

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ability to bring the projects to their districts as a way of showing effectiveness and enhancing reelection potential. To respond to the pressures, the MoF developed a set of rules for allocating funds. Not all politicians carried equal weight. Some could be ignored, others parlayed aside. The budgetary interests of the opposition usually received short shrift. Not in power, they had little leverage to browbeat the bureaucracy. With respect to the LDP, bureaucrats in the Budget Bureau left unassigned funds to permit politicians at the end of the annual budget process to resurrect some of the projects left on the cutting-room floor. The bureau also developed procedures for handling conflict among ministries, most noticeably the rule of equal treatment. Unique circumstances aside, the bureau imposed ceilings on budget increases (or, in the 1980s, decreases) that applied to all ministries. Whether a small increase or a real decrease, the bureau subjected all ministries to the same general treatment. Aware that all segments of the government were in a roughly identical position, the approach reduced complaints. It also, however, sidestepped a qualitative analysis of expenditures for each ministry, something that bureaucrats neither had the manpower to conduct nor the capacity to impose. Nor would the approach have been permitted by poli­ ticians. Those in the LDP had little interest in a more qualitative approach, something likely to generate controversy and alienate traditional constituencies. The result was that expenditures continued to appear in budgets and receive MoF approval long after the need for them had ended. For all of the arrogance and the dislike within the Japanese government at having to answer to MoF bureaucrats, the Budget Bureau’s management of the process was, in many respects, a success, at least from a macroeconomic per­ spective. In the 1980s, the bureau used its broad authority to reduce out-of­ control government spending and balance the budget. The efforts caused the Economist magazine in the early 1990s to characterize the MoF as the most effective finance ministry among developed nations. THE BUDGET PROCESS The MoF’s authority over the budget has been longstanding, although its absolute nature represents a more recent phenomenon. Moreover, as with many characteristics of Japan’s system, the process had its roots in the deliberate policies of the occupation. Allied officials viewed the budgetary system as insufficiently centralized and containing too much discretion in various government units. Military budgets during the war had often been approved by Imperial Ordinance, sidestepping the Diet. The decision was made, therefore, to ensure that all aspects of the budget were subject to political control and to ensure that a single organization, answerable to the electorate, had responsibility for overseeing formulation. The postwar Constitution democratized the budgetary process by placing the

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authority directly in the hands of the Cabinet. The action ensured that all au­ thority over the budget would rest with elected officials and not the Emperor or the military. The provision, however, proved largely symbolic. Practical au­ thority for the budget was almost immediately transferred to the undemocratic MoF. Under the Public Finance Law of 1947, another occupation-inspired piece of legislation, the responsibility for preparing the budget was handed to the MoF. The law contained a number of requirements that would have magnified im­ portance and later prove nettlesome. It prohibited multi-year expenditures unless specifically authorized by the Diet. The MoF, therefore, was expected to conduct a complete review of the budget each year. For practical, logistical and bureaucratic reasons, however, a complete review every year was impossible. The Budget Bureau instead spent the most time on new expenditures, glossing over those approved in earlier years. Other ministries learned that once an item received MoF approval, it could be reinserted into the budget every year, with little likelihood of renewed scrutiny. Annual spending patterns, therefore, were often based on bureaucratic considerations rather than rational decision making. The law also limited the ability to reallocate funds within a particular min­ istry’s budget. Changes were essentially prohibited once the Diet had adopted the budget. A ministry could, therefore, use funds only for their expressly au­ thorized purpose. To the extent any reallocation was possible, it required the affirmative approval of the MoF. In effect, the limitation built into the system a high degree of inflexibility, with ministries having little ability to change spending priorities as circumstances evolved. The budget followed a relatively predictable pattern. Following the end of the fiscal year (March 31), ministries determined their spending needs and reported them to the Budget Bureau. The bureau used the data along with revenue pro­ jections to determine budget ceilings for the following year, something submit­ ted to and approved by the Cabinet. The ceilings did not apply to all expenditures, particularly “ exceptional” expenses or certain obligatory pay­ ments, such as interest on the national debt. With the ceilings determined, the two sides would negotiate in the fall over the specifics and ultimately reach some type of agreement. Budgets would then be submitted to the Cabinet in December for last-minute “ political” corrections. After often-frenzied attempts by politicians to obtain changes, a final budget would be submitted to the Diet and adopted without change. Deviations are unusual and well known. The 1996 budget passed six weeks after the beginning of the fiscal year because of the dispute over financing for the jusen. The purpose and details of the annual budget ceiling have evolved over time. Under the sway of Finance Minister Ichimada, the Budget Bureau tried to limit government expenditures, irrespective of tax revenues received.' In the 1960s, however, the philosophy changed. The MoF, following the lead of Prime Min­ ister Ikeda and his income-doubling plan, shifted its approach and approved

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expansionary budgets. They were less a device for fiscal constraint than a mech­ anism for notifying other ministries of the extent of acceptable increases. Although expansionary, these budgets still had to balance. The goal was to match government expenditures and tax revenues. To do so, the Budget Bureau only had to predict with reasonable accuracy the increase in tax revenues and impose a ceiling that allowed growth up to that amount. Moreover, the bureau could conservatively estimate revenues, using supplemental budgets later in the year to allocate any additional amount. Budget management in the first 20 years after the occupation represented the glory years of the MoF. They came to an end in the 1970s when the policies of Prime Minister Tanaka and the consequences of the first oil crisis decimated Japanese finances. Deficits became the norm. Rather than matching tax revenues with expenditures, the Ministry suddenly found itself trying to sell enough deficit bonds to keep the government afloat. Expenditures, deficits, and the issuance of bonds escalated throughout the decade. The task of managing deficits proved infinitely more difficult than allocating increases. The Budget Bureau found itself having to impose on the government varying degrees of restraint, something that over time exacerbated tensions with other ministries and politicians. All goals were subordinated to the task of bal­ ancing the budget. The ceilings, therefore, no longer sought to align tax revenues and government expenditures, but instead to force down expenses in an effort to reduce the deficit. A complex task, success depended upon the extent to which budgets could be cut without generating a bureaucratic or political revolt. The change in objective could be seen from the shift in the ceilings. The caps on expenditures ceased to be tied to projections in increased tax revenues. In­ stead, they were used to ratchet down government spending. Contemplating reduced levels of growth in administrative spending, ceilings in the 1980s pro­ vided for annual increases that first fell below the rate of inflation and then became real decreases. A handful of bureaucrats within the MoF received credit for devising and implementing the tough approach. In the aftermath of the second oil crisis, the Budget Bureau, under the leadership of Yasuo Matsushita, then the director general and a future governor of the Bank of Japan, imposed a ceiling that allowed no increase in expenditures over the previous year’s budget. Two years later, in fiscal 1984, the bureau enforced a “ minus” or “ negative” ceiling, reducing general expenditures by 10% and public works by 5%. Credit for developing and enforcing the negative ceiling was generally given to Jiro Saito, who would eventually become administrative vice minister and a domi­ nant bureaucratic figure in the 1990s. Political and bureaucratic opposition to the negative budget ceiling ultimately developed and it had to be abandoned. Still, the bureau kept spending growth in check, significantly contributing to the process of bringing the budget into balance, something that occurred in 1990.

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THE BUDGET BUREAU The task of negotiating with other ministries over annual expenditures in the MoF fell to the Budget Bureau. The most important bureau in the most important bureaucracy, the office was sometimes referred to as the “ talent bank,” the location of the heavy hitters destined to hold the top positions in the MoF. The head of Budget invariably became the administrative vice minister, the highestranking career position. Only once in the post-occupation era was a director general not promoted. The timing of the annual budget is well known and generally runs on sched­ ule. The internal process for determining the budget within the MoF, however, is less well known. The bureau has three deputy directors general (shukei kyoku jicho), each in turn overseeing three budget examiners (shukeikan). The deputy directors general supervise the budgetary process for the particular ministries assigned to them. They remain extensively involved in the process, constantly interacting with the underlings actually conducting the budget negotiations, con­ sulting and approving new budget items, and handling particularly sensitive political matters. Shukeikan or budget examiners have a rank equivalent to section chief (kacho). Sometimes known as “ first examiners,” they are the ones who review the initial budget requests submitted by each ministry in the spring. They are not, however, as involved in the actual negotiations that take place in the fall. Beneath each shukeikan are three deputy budget examiners or shusa. Equiv­ alent to deputy directors or kacho hosa, the deputy examiners conduct the actual negotiations with each respective ministry. A shusa will be assigned to a single ministry and have the task of reviewing and ultimately lowering the demands of that bureaucracy. Budget examiner represents a relatively early but critical position for ministry officials seeking to become vice minister. In that regard, not all shusa are equal. The most important are those overseeing construction/public works, the most political part of the budget. Jiro Saito, the most powerful vice minister in the 1990s, held the position. Despite the obvious importance of the post, not all deputy examiners are career officials from the MoF. They are sometimes “ borrowed” from other ministries, a form of budgetary training. In addition, some budgets are viewed as less political and more technical— including the one for the MoF— with the deputy examiner a non-career official having the rank of kacho hosa. Deputy examiners receive a ceiling for their respective ministries and are judged by how close they come to that amount. In turn, deputy directors general have an aggregate ceiling for all of the ministries under their aegis and are judged by how close total spending comes to that amount. To the extent that one ministry receives increases above the ceiling, the deputy is expected to make up the difference from somewhere else in the budget.

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Shusa look for any legitimate basis to pare back new expenditures. The Fi­ nance Law theoretically requires a bottoms-up review each year, with all matters in a ministry’s budget subject to examination. As a practical matter, however, most of the energy in reviewing the budget focuses on new items. In effect, preexisting expenditures are treated as having been analyzed by others and not requiring reexamination. The result is a high degree of budgetary inflexibility, creating disincentives to more rational spending patterns. Ministries are usually unwilling to tamper with previously approved budgetary items, even if the funds can be more ap­ propriately deployed elsewhere. Reallocated funds will appear as new expen­ ditures and have to undergo rigorous review by the Budget Bureau. As a result, outmoded expenditures constantly reappear from year to year in ministry budg­ ets, largely unaltered. The negotiation process also involves excessively long days. Beginning in early September, deputy budget examiners meet with officials from the respec­ tive ministries, often 12 hours a day. It is not uncommon for MoF officials to subsist for long stretches on small amounts of sleep. They also disappear from their families, bunking in the “ Hotel Okura,” the space in the the MoF building reserved for officials spending the night. Assistant budget examiners work closely with deputy directors general in determining a ministry’s budget. Shusa provide continuous progress reports on the status of the negotiations, particularly about important new items in a budget. They will have a more formal meeting with, and more thorough review by, the deputy director general, usually within a month, concerning the just-completed budget. By the end of November, the long nights for the shusa are usually over. The negotiations typically involve disagreement and compromise. Officials from other ministries unhappy with a particular decision rarely go over the head of the deputy budget examiner and do so only in relatively clear circumstances. To the extent they do, the relevant deputy director general within the MoF effectively represents the last appeal. The director general of the bureau rarely intervenes directly in spending decisions. Only the most sensitive and political of matters incapable of resolution reach such a high level within the bureau. These often require direct negotiations with politicians, a task sometimes con­ ducted by the director general. Funding decisions over the bullet train required political resolution. Ministries also know that the process contains one last mechanism for rein­ statement of a project cut by the deputy examiner. MoF bureaucrats leave in the budget funds that can be used to pay for projects resurrected by politicians. Competition for the funds is fierce. Bureaucrats must beseech their ministers; ministers must negotiate with the finance minister; the finance minister must negotiate with the top officials of the LDP. Projects that survive the process are inserted back into the budget. The influence of the Budget Bureau does not end with adoption by the Diet. The bureau also has the power to oversee the reallocation of budgeted funds

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during the fiscal year. Any changes in the budget are either prohibited or require approval from the bureau. MoF officials, therefore, remain involved in spending decisions of ministries, at least those requiring changes in the existing allocation. The continuing power over a ministry’s budget effectively prevents any sig­ nificant reallocation during the fiscal year. In most instances, the bureau takes the position that specific expenditures approved by the Diet are laws that cannot be changed. As one bureau official put it, the budget process did not involve an “ approximation” or estimate of expenses, but resulted in a law that fixed the “ exact” amounts for specific items. Even if the shusa determines that some flexibility for reallocation exists, the agency or ministry must go through a rig­ orous vetting process, something it generally prefers to avoid. As a result, most ministries choose not to seek reallocation during the fiscal year but instead wait and insert the proposed new item into the budget for the following year. That also involves an extensive and cumbersome process. Bu­ reaucrats seeking the item need to make a formal written proposal within their own ministry. The request ordinarily has to be considered by the particular ministry’s secretariat. An accountant in the office analyzes the proposal, asking questions and perhaps insisting on changes. Assuming it survives the ministry’s own internal process, it has to then receive approval from the shusa in the Budget Bureau during the annual budget nego­ tiations. Those items that survive still must wait until formal approval of the budget by the Diet in February and then the beginning of the new fiscal year on April 1 for funding. The entire process, therefore, can easily take eight or nine months. As an example, a particular office with an immediate need for computer hard­ ware might be told there are no funds in the budget for the expenditure. Either the issue will have to be raised with the Budget Bureau, an unlikely event, or delayed until the next budget cycle. To the extent delayed, the head of the office making the request needs to expend considerable time justifying the additional expenditure. Moreover, assuming a two-year term in office before rotation to a new position, the initiating bureaucrat often will have moved to another position before the new computers arrive. All of this conspires against making the nec­ essary budget requests and builds into the process a high degree of rigidity. COLONIES The MoF’s influence over other bureaucracies derives from more than its central role in the budget process. Much of the Budget Bureau’s influence, including effective negotiations over the budget, arises from unique access to information. Information may come from any number of sources. Amakudari and the dispersal of retired officials throughout the financial sector, particularly public banks and corporations, represents critical sources of information. The Ministry traditionally places alumni in high-ranking posts in other investigatory agencies, including the Central Bank and the Fair Trade Commission.

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The MoF also, however, accumulates information about the bureaucracy from other sources. During their careers, bureaucrats ordinarily spend at least one tour of duty in another ministry. Different from amakudari, the officials are trans­ ferred during, rather than after, completion of a bureaucratic career. Often they are on temporary loan, returning to the MoF once their tour of duty in the particular support agency has ended. In a few cases the transfers are permanent, with those sent to high-ranking positions in the National Defense Agency an example. The practice allows MoF bureaucrats to build contacts in other ministries, something necessary for inter-ministry relations. They also, however, acquire information. The posts are often located in a secretariat, giving the bureaucrat access to information about the ministry’s budget, organization and personnel. Agencies claim that the acceptance of career bureaucrats from the MoF rep­ resents the only way to obtain such highly qualified officials. In reality, however, the agencies permit the practice largely to maximize their influence during budget negotiations. The MoF’s influence extends to a variety of organizations. Ministry officials regularly serve in the Economic Planning Agency, an organization responsible for economic forecasts. The Environment Agency, the National Land Agency and the Okinawa and Hokkaido Development Agencies have also been effec­ tively captured by the MoF. Perhaps most oddly from a policy perspective, the MoF has colonized the National Defense Agency. Founded in 1950, the NDA immediately allowed officials from the MoF to serve as director general of the Finance Bureau and director of the Finance Division within that bureau. In 1972, an MoF official for the first time became the administrative vice minister of the Defense Agency. Thereafter, Ministry officials generally controlled the top bureaucratic post in the agency. Another series of agencies more closely connected to the budget process have also been colonized or domesticated by the MoF. Known as the “ inspection” agencies, they include the Auditing Agency, the National Personnel Authority and the Management and Coordination Agency. These agencies provide impor­ tant supporting roles in the budget process. They have responsibility for matters ranging from the auditing of budget expenditures, to the setting of salaries, to the determination of any structural change in the shape of the bureaucracy. A creation of the occupation, the Auditing Agency makes certain that min­ istries and agencies have spent funds as authorized in the budget. The agency does so by conducting an annual review of expenditures. Colonized by the MoF, control of the Auditing Agency essentially completes the circle that explains the lack of flexibility in ministry budgets.2 To the extent funds are reallocated with­ out approval, it would appear to inspectors from the Auditing Agency, with penalties to follow. Caught in a vise, agencies have little choice but to spend funds for the precise purpose specified in the budget, even if current circum­ stances dictate otherwise.

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Should abuses arise, retribution may take place in the next budget cycle, with penalties exacted not by the Auditing Agency but by the Budget Bureau. The Auditing Agency found what it labeled as improper spending by the National Defense Agency in 1956. The MoF responded the following year by not in­ creasing the agency’s budget, giving as an explanation the loose accounting and existence of unspent funds by the Defense Agency. The Management and Coordination Agency represents another agency strongly influenced by the MoF. The agency oversees structural changes in the bureaucracy. It approves any change in the number of personnel at each ministry and the restructuring of bureaus and offices. A number of positions within the agency traditionally go to MoF officials.3 The National Personnel Agency represents the third of the “ inspection” agen­ cies. This agency decides salary levels within each ministry and, critically for the MoF, has the authority to approve private-sector amakudari positions taken by bureaucrats within two years of retirement. The Agency also controls deci­ sions on bureaucratic compensation, something that MoF bureaucrats oversee.4 Control of these agencies permits the monitoring of other agencies. In addi­ tion, however, they give the MoF the opportunity to use the contacts for its own benefit. In 1979, the National Personnel Agency approved the creation of 12 positions with a kacho salary level, all at the MoF. While it would stretch the point to contend that the MoF uses these agencies solely for its own benefit, it is certainly the case that capture provides a ready opportunity for the Ministry to make its case in favor of additional positions or structural changes. MYTHS AND REALITIES As a consequence of its control over the budget process, the Budget Bureau has been credited with almost complete domination of other bureaucracies. In other words, the MoF used the power of the purse to subjugate the rest of the bureaucracy. In fact, this represents another myth that includes a modicum of truth but is mostly an overstatement. First, the Budget Bureau’s overall power is limited. The MoF does not and cannot use the budget process to assert its own spending priorities. The authority has instead been used to advance macroeconomic goals, particularly balancing the budget or controlling deficits. The Bureau has been able to achieve these results by relying on a general rule of equal treatment. Other bureaucracies may have to accept a low ceiling on increases (or even decreases) but they know that everyone else must do likewise. Any attempt by the bureau to unilaterally undertake a more qualitative analysis would threaten the relative acceptance of the MoF’s role in the process and impair the macroeconomic goals. Bureaucrats in the Budget Bureau, therefore, have little capacity to qualita­ tively review budgets even if they had the inclination. Past attempts foundered when politicians intervened. Other ministries would turn to their interest groups and allies in the Diet, increasing the degree of political involvement in the

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budget process. When the bureau tried to cut agricultural expenditures in the early 1960s, politicians intervened. Traditional bureaucratic dynamics also conspire against any effort to take a more qualitative approach. Under the Finance Law, the annual review process must involve an analysis of all items within a particular ministry’s budget. As a practical matter, however, this has proved impossible. Deputy budget exam­ iners, the ones primarily responsible for analyzing the budget, came into the position with no experience and were assigned to a particular ministry for only two budgetary cycles. With the budget process occurring over a relatively short four-month period from September through December, the examiners had no time for a complete review. Within the Budget Bureau, deputy examiners also had little incentive to un­ dertake a qualitative review of a particular ministry’s budget. Doing so could cause controversy, something that would slow negotiations and possibly engen­ der political intervention. Their supervisors would be unlikely to support such an effort. Moreover, examiners were not judged by the thoroughness of their reviews but by their ability to remain within the ceilings set by the bureau. Without a qualitative analysis, expenditures remained in the budget even after their usefulness had long since ended. The budget continued to provide consid­ erable support to the agricultural sector, despite its declining importance. Allo­ cations for particular categories of construction projects (as a percentage of the budget) tended to remain the same, notwithstanding evolving infrastructure re­ quirements. The result was a budget process that resulted in highly inefficient expenditures based upon historical rather than current priorities. From a macroeconomic perspective, therefore, the MoF’s approach toward budget negotiations brought considerable discipline to the expenditure process. In general, insistence on a balanced budget and other manifestations of fiscal conservatism resulted in significant controls on government spending. Only when the bureau lost control of the budget process did expenditures escalate and the deficit balloon. From a microeconomic perspective, however, the process was less successful. It did not involve much creativity. Rote rules and inertia controlled the process. Equal treatment of the various ministries and agencies represented a principal tenet, not because it made economic sense but because it minimized bureaucratic conflict. Given dramatic changes in the state of the Japanese economy, the continued lack of qualitative analysis has grown inefficient. Spending priorities have not kept pace with the country’s economic transformation. Even at the MoF it took years before funds were reallocated to provide its own employees with com­ puters. They did not appear in Ministry offices (other than personally owned ones) until the 1990s, a significant delay given the rapid advances of the infor­ mation age. Reform, therefore, should occur, but not in the way usually suggested. Having a strong administrator overseeing the budgetary process has worked well. In-

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deed, if a problem exists, it arises out of the lack of career staff needed to conduct more thorough reviews of agency budgets. In the transformed economy, a control mechanism over aggregate spending will still be required. The system must evolve, however, to build a qualitative examination of budgetary matters.

CHAPTER 11

The Political Role of B u re a u c ra ts

The reigning myth is that bureaucrats act independently of the political process. In general, the specifics of policy formulation in the financial area falls to the Japanese bureaucracy rather than politicians. The Minister of Finance, not the Diet or Cabinet, originate and draft legislation. The Diet simply adopts what the MoF submits. It is this myth more than anything else that leads to the conclusion that bu­ reaucrats must be “ overthrown” for the transformation of the Japanese economy to take place. Politicians need to seize power back from bureaucrats. Yet the approach ignores the fact that politicians already exercise considerable control over bureaucratic policies and impose considerable constraints on Ministry be­ havior, although not always in an obvious fashion. The appearance of bureaucratic power benefits politicians. At every step of policy formulation, politicians are involved and can exert influence. At the same time, however, they relentlessly try to avoid responsibility. By attributing con­ troversial decisions to the bureaucracy, politicians obtain the benefits but avoid the consequences for any resulting controversy. The bailout of the jusen showed how that could work. Politicians deliberately left certain tasks to the bureaucracy. The most impor­ tant was consensus formation. Bureaucrats worked out differences among di­ verse interest groups important to the LDP. Bureaucrats, not politicians, solicited views and maintained communications with the principal groups affected by the reform. Politicians, however, routinely received progress reports. No significant step could occur over their objection. The result was the deceptive appearance that the MoF controlled.the reform process, understating the true balance of power.

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Both the private sector and politicians benefited from the appearance and did little to tamper with the myth of bureaucratic authority. By allowing bureaucrats to engineer the specifics of the reform, politicians did not have to take sides, at least overtly. They could avoid alienating important constituencies and shift blame to bureaucrats if matters did not function as ex­ pected. Whatever hard feelings arose out of the consensus-building process, the blame rested with bureaucrats, not politicians. Viewing ministry functions as part of a political process provides a better understanding of the dynamics of bureaucratic behavior. The incremental nature of reform and the need for consensus had as much a political as a bureaucratic explanation. Bureaucrats, including the MoF, knew that limits existed on their authority to dictate the direction and pace of reform. Efforts to move too quickly would likely harm some constituency and invite political disapprobation. As a result, the MoF had little ability to impose or engineer dramatic change. Similarly, the “ anti-consumer” nature of MoF policies during the postwar period also had a political explanation. The consensus-building process included only the constituencies important to the LDP, with other voices rarely heard. In the postwar era, the LDP had little interest in consumers as such. A bureaucratic initiative designed to benefit consumers at the expense of industry or other important LDP constituencies would have met with political disfavor. These limitations on bureaucratic behavior had practical effects. The need for consensus and the parameters established by politicians meant that the bureauc­ racy rarely embarked on bold, novel initiatives. They also had little opportunity to reach out to constituencies or interest groups outside those favored by the LDP. To do so would raise political objections, putting an end to the approach. ARBITRATING DISPUTES The MoF’s task as arbiter is perhaps its most important political role. In the area of financial reform, the Ministry oversees the negotiation process, solicits views, digests comments and moves the process toward a consensus accepted by key participants. The role has served the interests of politicians. The LDP let the MoF arbitrate contentious and controversial issues while appearing to stay above the fray. In the case of financial reform, the MoF had the task of achieving a consensus over the proper direction within the affected industries. The process involved sharp disagreements, lengthy discussions and intense lobbying. It was the MoF, not politicians, that brought most disputes to resolution. The MoF has exercised this role at least since the occupation. The nature of the process, however, has undergone considerable change. For most of the post­ war period, the primary task was to enforce the reigning consensus. Each set of financial institutions had its own niche and vigilantly guarded its monopoly. It was left to the MoF to ensure, in this financial state of nature, that one category

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did not intrude into another and that, within each category, no single financial institution obtained a destabilizing advantage. Industry approved of the MoF’s role. So did politicians. With a clear consen­ sus and widespread support, bureaucrats had considerable latitude to carry out their mission. Financial institutions that deviated were punished. Major devel­ opments were precleared with the MoF. For much of the economic recovery phase, the financial system functioned effectively and the MoF’s role remained uncontroversial. Within these broad goals, however, the MoF had little room to implement dramatic change. The financial markets were altered at the margins, but the fundamental approach to regulation remained unchanged. As long as funds went to the key industries and the principal segments of the financial community were content, the MoF had little incentive to alter the shape of the regulatory system and politicians had little reason to intervene directly. It also meant that the MoF could implement reform with little opposition or controversy, as long as it merely involved maintenance of the compartmentalized financial system. Trust departments of city banks were ordered to divest. Branch networks were subject to bureaucratically imposed constraints on size. Interna­ tional expansion other than for the Bank of Tokyo was limited. With the end of the postwar capital shortage, however, the role of the MoF underwent pronounced change. Enforcement and mild tinkering were no longer enough. The status quo in the financial markets quickly became untenable. Rather than ensuring effective operation, the MoF had to engineer a complete abandonment of the system and develop a regulatory regime more consistent with competitive financial markets. The shift in responsibilities made the MoF’s task far more difficult. It had to convince all segments of the financial markets to give up their respective mo­ nopolies and accept greater competition. It would generate winners and losers. While some financial institutions would thrive, others would disappear or would watch their profits plunge as competitors entered their previously protected niches. The approach was bound to and did generate vast amounts of suspicion and opposition within the financial industry. The MoF’s role, therefore, lacked the same degree of support and, in some cases, generated outright opposition. Change required a slow process of cajoling, bargaining, and opportunistic be­ havior. Incremental reform was unavoidable. Any attempt to boldly alter the financial markets would have upset important constituencies and made a consensus im­ possible. Moving forward in the absence of consensus invariably generated com­ plaints to politicians. Politicians in turn could interfere with or even block proposed reforms. In general, therefore, they intervened overtly only when the MoF failed to obtain the requisite consensus among affected industries or ministries. In the postwar era, the LDP had to arbitrate a number of interministry conflicts between

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the MoF and the Ministry of Posts and Telecommunications, the ministry re­ sponsible for the Postal Savings System; MITI, the ministry in charge of non­ banks, and the Bank of Japan. Similarly, when the Banking Bureau sought stricter reporting requirements in the early 1980s over the opposition of financial institutions, complaints to politicians put an end to the effort. The seemingly endemic characteristic of slow and incremental change, therefore, largely had a political explanation. Overt appeals by industry to politicians were uncommon. Political influence was more pervasive and more subtle. An unhappy interest group or constituency would meet with key politicians. The politicians would then demand to see MoF bureaucrats, seeking an explanation for the approach. Bureaucrats might succeed in convincing the politician that the concern was unfounded. Otherwise a poli­ tician could have the matter scheduled for discussion at a bukai meeting, the relevant subsection of the LDP’s Policy Research Council. With opposition de­ veloping and political interest increasing, bureaucrats had every incentive to find a compromise acceptable to the relevant interest group. Where interest groups were not sufficiently satisfied with the immediate di­ rection of reform, therefore, the MoF had little room to act. Politicians repre­ sented a brooding specter that could be brought into the process at any time. To the extent that the MoF did not handle the reform process with sufficient tact, constituencies would complain and appeal to their allies in the Diet. On the other hand, as long as the MoF operated within politically acceptable par­ ameters, it could develop the requisite consensus, with the specifics of reform relatively free of overt political interference. Bold or more dramatic reform was possible only where political support was neutralized, allowing the MoF to implement the change without fear of inter­ vention. In particular, political allies tended to disappear during periods of fi­ nancial scandal, providing an opportunity for bureaucrats. During the compensation scandals, political support for securities firms evaporated, enabling the MoF to push through legislation that ended the separation between banks and brokers. Incremental and slow-paced reform, therefore, had a political rather than bu­ reaucratic explanation. Bureaucratic habit did reinforce the tendency. The MoF often lacked the internal expertise and, concomitantly, the confidence, to imple­ ment bold initiatives, particularly in the financial markets. The lack of industry experience and the system of rapid rotation also discouraged risk-taking and decisiveness. In many respects, obtaining a consensus and engaging in incre­ mental reform represented the most risk-averse and, concomitantly, the bureau­ cratically preferred, approach. Bureaucratic behavior, however, represented at best only a partial explanation for the often stultifying pace of change. Indeed, the MoF was capable of en­ gaging in bold reform efforts, even where they were not wholly accepted by private-sector participants. Changes arising out of the Yen/Dollar talks between

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the United States and Japan were substantial and not entirely supported by do­ mestic financial institutions. The subtle but unmistakable influence of politicians in the reform process helped put the role of foreign pressure into perspective. From the bureaucratic perspective, gaiatsu represented only an additional consideration in an already complex consensus-building process. Foreign banks were simply another con­ stituency that had to be weighed in forging agreement over change in the fi­ nancial system. Foreign pressure, however, sometimes had a more pronounced affect. It could alter the political equation. The fear of damaged relations with the U.S. or of retaliation against Japanese industry made politicians less willing to accept the objections of domestic financial institutions. The effect was to give the bureauc­ racy expanded negotiating parameters. The MoF could forge a consensus with reduced concern over domestic opposition since unhappy participants had less room to appeal to politicians. In the Yen/Dollar process in the early 1980s, traditional dynamics changed, with the MoF accurately assessing political considerations and pushing through relatively bold reforms. Foreign banks wanted an end to the compartmentalized financial system, an extraordinary demand. They wanted to engage in trust bank­ ing and securities activities. Ultimately, the efforts succeeded, with the expla­ nation at least partly political. The usual constraints imposed by politicians were not present. Prime Minister Nakasone had insisted on an agreement in order to maintain harmonious rela­ tions with the United States. His attitude reduced the likelihood that unhappy constituencies would successfully appeal to politicians. Bureaucrats knew, therefore, that political support existed for some change, even if the effect was not fully supported by domestic financial institutions. Other examples existed. Scandal could neutralize political support. When the compensation scandals surfaced in the early 1990s, political support for secu­ rities firms evaporated. Bureaucrats used the opportunity to push through leg­ islation to decompartmentalize the financial system and end the separation between banks and securities firms. The MoF also had additional latitude where an appeal to politicians lacked credibility. Large commercial banks were unhappy with reforms devised by the MoF in the early 1980s. Notwithstanding their unhappiness and the risk that they would seek political intervention, the MoF pushed ahead with the reforms. Bureaucrats did so knowing that political support was unlikely. Political inter­ vention would have upset other constituencies, particularly securities firms. Pol­ iticians were unlikely to take such a contentious step. As a result, when the appeal was made, little came of it. Bureaucrats, therefore, were generally free of overt political influence. Re­ taining independence, however, meant a sophisticated understanding of the reigning political goals. In the end, the MoF had relatively free reign only be­ cause it did a proficient job achieving consensus on the direction of reform

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without conflicting with the broad political goals of the LDP. To the extent the MoF failed to operate within those parameters, political intervention would occur. REFORM IN PRACTICE Much of the MoF’s efforts at reform had been designed to reduce overt in­ volvement by politicians in areas of bureaucratic oversight. The entire reform process, therefore, involved a host of compromises and devices designed to achieve consensus among affected industry groups and avoid appeals to politi­ cians. Most reform efforts tended to follow relatively standard patterns. Once the need for some type of change had been identified, the appropriate subdivision of the MoF would have responsibility for developing the necessary consensus. Often that meant the Secretariat, which had primary responsibility for interaction with the Diet. Sometimes, however, responsibility fell to the bureau with over­ sight over the affected industry. The first step usually involved the solicitation of comments by MoF officials from important interest groups. This was largely limited to constituencies im­ portant to the LDP. The relevant bureau would absorb the comments and attempt to draft a position likely to win widespread support. By definition, the prelim­ inary position would attempt to assuage the main concerns of each important group. From the very beginning, therefore, the proposals involved considerable compromise. The process of discussion and solicitation of views could take considerable time. Financial institutions might need to determine their own internal position. For industry-wide changes, MoF officials might deal with a trade association such as the Federation of Bankers Association or a self-regulatory organization such as the Tokyo Stock Exchange. They in turn would have to develop an industry-wide consensus. Once positions had become clear, a draft of the pro­ posed reform would be circulated. The process did not occur in a political vacuum. Important politicians would be kept informed. Even at these early stages, interest groups would frequently express concern to politicians, anticipating that they would raise the matter with officials from the MoF. Bureaucrats might even make a presentation to the bukai overseeing financial matters. Discussions, however, were often informal and individual. With the contours of the reform having become relatively clear, the Ministry would convene an advisory council to take up the issue. The council traditionally included representatives of industry, academia, relevant associations, a member of the mass media, and the Bank of Japan. The council created the appearance of broad-based deliberation by a cross section of the affected community. In reality most of the decisions had already been made among industry participants, rendering the council a formality.

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Moreover, MoF officials controlled the deliberation process. They would set the agenda, provide logistical support and generally manage the process to en­ sure the predetermined outcome. The Ministry’s position was facilitated by the usual practice of including retired bureaucrats on the council.1 In addition, with the possible exception of the representative of the Bank of Japan, the MoF had a monopoly on information, making it difficult for other council members to object or take independent positions. Once the council issued a report, a document written by officials in the rel­ evant bureau, drafting the required legislation usually amounted to a straight­ forward process. Important interest groups had been consulted, critical issues resolved. Draft legislation did have to be reviewed and approved by other af­ fected ministries, sometimes resulting in sharp conflict and compromise. Once agreement existed among important constituencies and bureaucracies, however, politicians in the Diet had little interest in disrupting the end result. The matter would still require approval of the relevant bukai of the Policy Research Council within the LDP. Having kept the key members informed at every juncture and already reflecting their views, bureaucrats knew that final approval would be a formality. Adoption by the Diet without amendment was, therefore, common. As a result, the lack of legislative change, something often used to show political impotence, in fact demonstrated the reverse. The absence of amendment illustrated maximum agreement among important constituencies and maximum input of politicians. In particular, the MoF was skilled as assuaging the interests of politicians and constituencies in the legislative process. BUREAUCRATIC AMBIVALENCE For a bureaucracy that tried so hard to avoid overt political interference in its activities, the MoF had widespread and close contacts with politicians. Bureau­ crats maintained the connections for a host of complex, not always compatible, reasons. Foremost, the relationship facilitated policy implementation. The MoF could not act in the face of strong political opposition. Officials in the Ministry therefore spent considerable time visiting key politicians, obtaining their consent and keeping them informed. The need for and common nature of the contacts generated considerable bu­ reaucratic ambivalence. Officials within the MoF often characterized the optimal relationship as “ equidistant from all politicians,” suggesting neutrality as the preferred approach. In practice, however, the MoF engaged in activities that were the antithesis of neutrality. The Ministry prized effectiveness. Given the postwar domination of the LDP, this meant maintaining good relations with the most powerful politicians in that party, hardly a policy of equidistance. The MoF’s attitude about politicians and aversion to political influence, how­ ever, dictated that .the contacts be subtle. Overt identification with a particular party or faction within the LDP would suggest politicization of the bureaucracy

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and could damage upward mobility. Promotions purportedly rewarded effect­ iveness rather than political affiliations, an often unclear distinction. From the very beginning, new recruits to the Ministry were introduced to the political process. Only at the MoF did first-year career officials have responsi­ bility for roaming the halls of the Diet to seek out questions to be asked by opposition politicians. With the Diet session lasting 150 days and special ses­ sions common, new recruits often devoted much of their first year to the task. Political interaction would become a fixture of a bureaucratic career, at least for those scheduled to attain the highest reaches within the MoF. Particular positions had constant and extensive contact with politicians. Relatively early, select career officials served as secretary to the finance minister. The positions provided opportunities to build long- term relationships and to establish contacts with a pretender to the position of prime minister. So important within the bureaucracy, they often amounted to stepping stones to administrative vice min­ ister. The MoF had other inherently political positions. Those in the Secretariat often interacted with the politicians. The Secretariat coordinated relations with the Diet. The director of the Documentation Section (bunsho kacho) was a po­ litically sensitive position and an important step to anyone with ambitions to become vice minister. The role of politicians did not mean that the MoF was a passive participant in the process. The Ministry knew how to take advantage of circumstances. When the government was headed by weak faction leaders, the MoF could delay unwanted policy initiatives, dragging its bureaucratic feet, in the hope that the government would change. In addition, the relationship included a number of unwritten rules and under­ standings. Politicians did not intervene, overtly into the affairs of the MoF. Pol­ iticians did not, for example, specifically overturn administrative promotions. Prime Minister Tanaka caused shock waves when he suggested that politicians should approve anyone rising to the level of director of a section within a bureau or higher. The implicit understanding only worked, however, because bureaucrats within the MoF did not appoint people antagonistic to reigning power brokers within the LDP. When Hashiguchi, head of the Budget Bureau, became the heir ap­ parent to administrative vice minister, his appointment did not occur because his close connections to Fukuda made him unacceptable to Tanaka. Similarly, when politicians wanted Sakakibara to become international vice minister, bu­ reaucrats relented and gave him the promotion, despite his lack of mainstream qualifications and considerable opposition within the MoF. Promotions within the MoF often took into account factional balance. When Masami Kogayu, someone with support in the Ohira faction, became head of the Personnel Section (hisho kacho) in the Secretariat in the early 1980s, Hiroshi Yasuda, someone identified with the Fukuda faction, was made head of the Documentation Section (bunsho kacho). With both positions mainstream stops

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on the way to vice minister, the MoF essentially ensured that it had two can­ didates for vice minister, at least one of which would be acceptable to the faction in power at the time promotions occurred. Part of the MoF’s relationship with politicians also involved the ability to meet their needs. Subtle but unmistakable political considerations permeated the budget process. During negotiations between the Budget Bureau and the other ministries, politically sensitive matters were identified early in the process, re­ ceiving special consideration. Politicians also sometimes intervened more di­ rectly. To address the inevitable last-minute pressure for increased spending, the Budget Bureau kept hidden reserves. During the budget process, the Ministry buried funds for use in the reallocation process that occurred during the final stages of budget negotiations. While politicians might not get all of what they wanted, there was something there for them. The MoF had one weapon in its arsenal that ostensibly caused concern among politicians. This was the power to initiate tax investigations. The authority to do so fell to the National Tax Administration Agency, a semi-independent af­ filiate within the MoF. Theoretically autonomous, the Tax Agency was not sub­ ject to the direct control of the other bureaus. Nonetheless, the connections were close. The director of the Tax Agency was usually a former director general from one of the bureaus, typically from the Tax Bureau. Moreover, the office always had a number of career officials bor­ rowed from other bureaus, particularly Tax. The belief, therefore, was that in­ vestigations by the Tax Agency were often begun at the request of the other bureaus. Politicians had exposure in the area. Questionable fund-raising was a common dynamic in the political system. The discovery of gold bars and bonds in the office of Shin Kanemaru, the former kingmaker for the LDP, illustrated the point. The possibility existed, therefore, that politicians tampering with MoF independence might find themselves subject to heightened scrutiny from tax authorities. In fact little evidence supported the contention that the MoF had made much use of its tax authority to threaten or control politicians. Indeed, given the wide­ spread belief in illegal fund-raising in Japan, it was more notable how seldom tax authorities investigated politicians. When Kanemaru incurred serious prob­ lems, speculation arose that others close to him (including Ozawa) would have similar problems. The investigation, however, never went beyond Kanemaru. If anything, therefore, the Faustian bargain between politicians and bureau­ crats included an understanding that in fact the tax authorities would rarely look into these types of financial matters. Anecdotally, it seems that the MoF has been much more likely to request the assistance of tax authorities in connection with the private sector. Financial institutions would complain of the curious juxtaposition between angering the MoF and visits from tax authorities. In the political realm, however, the approach seemed seldom used.

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Indeed, politicians would not tolerate an MoF that could and would resort to blackmail. In those circumstances, politicians would be forced to take steps to ensure that the power remained dormant. The only way to do so would be to exert direct political control over the bureaucracy. With politicians currently debating the structural reform of the bureaucracy, they would have plenty of cover for stripping away the MoF’s tax investigatory authority. Threatening to use the power to investigate politicians for tax violations, therefore, would lead to exactly the opposite result desired by the MoF. OF POLITICS AND BUREAUCRATS The MoF performs an intensely political role. Bureaucrats arbitrate disputes among constituencies important to the ruling party. Moreover, the role arises not from some type of unfathomable cultural norm or inherent bureaucratic power but because politicians tolerate and encourage the arrangement. Politicians gained by leaving contentious matters in the hands of bureaucrats. They avoided having to take sides in serious disputes. They knew, however, that the consensus that emerged would be within an acceptable range of change and would not antagonize important constituencies. Only when the MoF ex­ ceeded these parameters did overt political intrusion become necessary. The process benefited politicians in another way. To the extent that reforms did not work or somehow antagonized the public, the blame would be placed on those appearing responsible. That meant bureaucrats rather than the politi­ cians. Public anger at the bailout of the jusen was placed squarely at the feet of the MoF, even though government funding was only required because of polit­ ical intervention on behalf of the regional agricultural cooperatives. Similarly, the consumer-unfriendly nature of the financial system could be and was blamed on bureaucrats and their excessive closeness to industry, rather than limitations imposed by politicians on the interest groups that could participate in the con­ sensus-formation process. Industry also preferred bureaucratic rather than political development of re­ forms. While reform did generate winners and losers, those disadvantaged knew that they had their best opportunity to soften or delay changes at the bureaucratic level. They knew that the MoF could not impose reform over the adamant opposition of an affected industry. An appeal to politicians, on the other hand, would generate more uncertain outcomes. As a result, industry stood to gain the most in the bureaucratic decision-making process. Those within industry also preferred that unpopular policies emanated from the MoF. It was more palatable to explain to shareholders that they were bailing out an unhealthy financial institution because of orders from bureaucrats rather than admit that it was dictated by their own profligate lending practices. Despite the appearance of relative freedom, therefore, MoF officials remained intensely aware of the political consequences of their actions. In the end, the MoF had relatively free reign only because it did a proficient job achieving

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consensus on the direction of reform without conflicting with the broad goals of politicians. To the extent the MoF failed to operate within those constructs, political intervention was more likely. Viewing the performance of the MoF as political provides insight into the future. Even without “ overthrowing” the bureaucracy, politicians already have the power to change the bureaucratic decision-making process. Moreover, as political dynamics change, the interest groups favored by politicians will change. Political change will, perforce, result in shifts at the bureaucratic level, even without legislative reform.

CHAPTER 12

The B u reau cratic Role of Politicians

In discussing development of the budget or the introduction of financial reform, the tendency has been to minimize the role of politicians. Only a small number overtly tried to influence the bureaucracy in a broad and public sense. Ikeda succeeded; so did Tanaka. Nakasone wanted more for defense and got it. Focusing only on these examples, however, misses most of the influence that does occur. In fact, political considerations permeate the entire bureaucratic process. In the annual budget process, ministries know that the MoF will try to control expenditures and impose ceilings on increases. To overcome these lim­ itations, they aggressively seek political support. Politicians, in turn, become involved in an effort to maximize effectiveness, something often rewarded at the ballot box. Bureaucrats and politicians, therefore, engage in constant contact and seek to build strong relationships. Contacts occur through a variety of means. Bureau­ crats and politicians develop connections while in school, through marriage, or on the basis of geography. The mechanisms are exceedingly rich and surpris­ ingly subtle. Mostly though, they develop through relentless interaction. Contacts, relations, and goals create a symbiotic relationship between politi­ cians and bureaucrats. Politicians need bureaucrats; bureaucrats need politicians. The Ministry of Finance, therefore, has an incentive to work closely with the power brokers in the Diet. The close connections explain a number of things about political efforts to reform the bureaucracy. For politicians with sufficient influence, the bureaucracy does not constitute an impediment, but will generally be receptive to their en­ treaties. Rather than limiting political goals, bureaucrats often facilitate them. Reform designed to make the bureaucracy more accountable, therefore, ignores the high degree of accountability that already exists.

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Those opting for a more confrontational approach with bureaucrats tend to be either out of power or responding to public sensitivities. For those with little bureaucratic influence, confrontation is often a substitute for effectiveness. When implemented for public consumption, bureaucratic reform is not designed to improve effectiveness but to exact retribution. SUBTLE CONNECTIONS Politicians and bureaucrats in the MoF have longstanding connections that are intentionally developed and assiduously maintained. The most obvious man­ ifestation of the contacts occurs in connection with the high number of MoF officials who have turned to politics as a second career. In 1992, 27 of the Diet’s 511 members were former MoF bureaucrats; 22 in 1998, including the Finance Minister, Hiroshi Mitsuzuka. The statistic reflects the political ambitions of many bureaucrats within the MoF. The task was made easier by the concentration of influence. Traditionally, MoF officials entering politics did so exclusively under the LDP banner, al­ though since 1993 that has no longer been entirely true. They needed, therefore, to develop contacts in, and support the policies of, a single party, something that engendered a tendency to pay reduced attention to opposition politicians. Bureaucrats in the MoF overwhelmingly come from the University of Tokyo. Although Todai does not have a comparable monopoly on Diet members, a significant number have in fact been educated there. Invariably, therefore, Todai graduates from the same class served simultaneously in the Diet and in the MoF, providing a natural connection between politicians and bureaucrats. Koichi Kato, the secretary general of the LDP and Wakui, the head of the Budget Bureau, were classmates. Some MoF officials came directly from political families. Iichiro Hatoyama, the son of a former Prime Minister, spent his first career in the MoF. He became administrative vice minister before retiring and successfully running for the Diet. Similarly, Kiichi Miyazawa’s father had been in the Diet until purged during the occupation. Miyazawa joined the Diet after beginning his career in the Min­ istry. Moreover, the pattern was continued. His nephew, Yoichi, entered the MoF in 1964, eventually resigning to pursue a political career. The reverse has also been the case. Some politicians came from bureaucratic families. Prime Minister Hashimoto’s father began his career in the Ministry in 1934 before entering politics.1 Iichiro Hatoyama, a member of the class of 1941, rose to vice minister in the MoF, with his sons Yukio and Kunio both becoming politicians. Marriage represents another seldom-discussed link between politicians and bureaucrats. Marriage to a career official in the MoF is considered highly prized. Sometimes known as “ breeding horses” or tane uma, MoF officials are con­ sidered attractive candidates for marriage. Special parties are arranged to intro­ duce rising MoF career officers to eligible candidates.

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In fact, the hisho kacho or director of the personnel section in the Secretariat of the MoF has primary responsibility for developing these matches. Fumio Takagi reputedly arranged more than 20 such marriages while he was in the position. Even powerful MoF officials may want to use marriage to continue their bureaucratic dynasty. The daughter of Jiro Saito, a powerful administrative vice minister, married a high-flying MoF bureaucrat. The examples of political and bureaucratic intermarriages are numerous. Hajime Morita, an MoF career official from the class of 1957, married the daughter of Masayoshi Ohira. Toshihiko Asami, class of 1966, married the second daugh­ ter of Zenko Suzuki. Michio Ochi married the daughter of Takeo Fukuda. Other examples also exist.2 The marriages are often designed to keep a Diet seat in the family. Mitsue Ikeda, the wife of the former prime minister, reputedly approached the hisho kacho to find a spouse for her daughter. She wanted someone capable of taking over her husband’s seat. Yukihiko Ikeda was selected, promptly left the MoF, and won the seat. He is still in the Diet. The approach has a number of implications. Not all or even a majority of bureaucrats aspire to a political career. Nevertheless, the Ministry contains an ambitious minority with political aspirations. They effectively search for ways to build bridges to politicians. Politicians, in turn, constantly seek contacts and allies within the bureaucracy. The strength of the communication flow has been increased by its narrow nature. Both the MoF and the LDP traditionally in­ teracted with each other, almost entirely to the exclusion of other political parties. INFLUENCE PEDDLING Relations between the MoF and politicians have always been extensive. With miniscule staffs, Diet members rely on bureaucrats to provide information, draft reports, and write legislation. Ministers have bureaucrats on their staffs and use them to craft speeches and devise answers to questions posed by the opposition in the Diet. Cabinet meetings often constitute staged events, with politicians simply reading remarks prepared by bureaucrats from their respective ministries. Any politician, whether in the LDP or an opposition party, can request in­ formation from bureaucrats, although the quality of the response will vary. The completeness of the material increases the closer the official comes to the center of political power. In general the MoF does not consult opposition parties on legislative matters, limiting itself to the parties in power. Nor do the bureaucrats pay particular attention to the budgetary interests of opposition members. The most significant contacts are between bureaucrats in the MoF and senior politicians in the LDP. Influential politicians include the top four party positions, the important members of the relevant division (bukai) of the Policy Research Council, and the members of the MoF zoku or tribe. The top party positions consist of the president, usually but not always the prime minister,3 and the three

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principal party officers: the secretary general of the party, the chair of the Policy Research Council, and the chair of the General Council. In addition, the MoF has constant contact with the relevant division (bukai) within the Policy Research Council responsible for financial matters, with the chairman particularly important. The LDP has committees that roughly corre­ spond to each substantive committee in the Diet. For the MoF, the two most important committees are the Research Committee on Finance and Banking Systems and the Special Committee on Financial Problems.4 The committees have considerable expertise and contain officials who often came from one of the financial bureaucracies. Any important matter under consideration by the MoF, whether legislative, administrative or disciplinary, will be a subject of discussion at a bukai meeting. A consensus reached at one of these meetings will be binding on bureaucrats. Important constituencies unhappy with bureaucratic actions can and do lobby politicians on the bukai to raise the matter at the next Tuesday meeting. Given the importance of the meetings, officials from the MoF regularly attend and make presentations. In addition, they will meet individually with bukai members to lobby them and to ensure that their views carry the day. Efforts to make the Bank of Japan more independent of the MoF illustrated the crucial role of the financial bukai. After tough negotiations, the LDP and its two coalition parties, the Socialists and Sakigake, came to an agreement on amending the Bank of Japan Law to provide greater independence for the central bank. Agreement was first reached in June 1996 and reaffirmed in the fall. Simply agreeing on the matter was not, however, enough. The government took steps to build support for the reform. The prime minister set up a special study group to consider the matter, with the Central Bank Study Group issuing a report in November 1996 supporting the reform. In addition, the matter was taken up by the Financial System Research Coun­ cil, an organization usually controlled by the MoF. Bureaucrats lobbied the council and won some small victories, including the right of the finance minister to review the budget of the central bank. Nonetheless, the council, in a report issued on February 6, 1997, called for increased independence. With both a study group and the council examining the issue, the matter received consider­ able attention in the press, creating popular support for the change. The coalition government supported the reform. The relevant council was behind it. Considerable public support for greater independence had developed. The reform seemed inevitable. It was not. Matters still had to be considered and approved by the traditional mechanisms within the LDP. That meant the financial bukai, a bastion of support for the MoF and, at the time, headed by a retired bureaucrat.5 When proposed legislation was published, Taku Yamasaki, the chairman of the Policy Research Council, indicated lukewarm support, suggesting that some control of the Bank of Japan by the Minister of Finance (and, perforce, the bureaucrats within the MoF), was necessary.

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With supporters in the bukai, including retired bureaucrats, the MoF mobi­ lized in an effort to stop the legislation. Bureaucrats lobbied some (but not all) of the members and convinced them to oppose the change. The efforts seemed successful, with reforms at a standstill. The reforms ultimately passed, but only after Koichi Kato, the secretary gen­ eral of the LDP and Yamasaki, the chairman of the Policy Research Council, personally intervened and convinced members that adoption was critical to the prime minister’s reform program. But for unusual intervention at the highest political levels, the efforts to make the central bank more independent would not have made it out of the bukai. In addition to the bukai, political influence over the bureaucracy occurs through zoku or tribes. The term has a variety of meanings, most of them pe­ jorative. It encompasses groups of politicians interested in, and knowledgeable about, particular ministries. The pejorative part comes from the suggestion that members create alliances with interest groups to influence the bureaucracy in return for a quid pro quo, presumably some type of financial contribution. Some have labeled the approach institutionalized vote buying. The label can be extended to anyone with particular ability to influence a particular ministry. Some former MoF officials who enter the Diet may be con­ sidered zoku because of their knowledge about the workings of the bureaucracy. On the other hand, the term is sometimes limited to those who are powerful enough that the bureaucracy has little room to resist. Most zoku are located within the relevant committees of the Policy Research Council.6 Zoku can be divided into two broad categories: weak and strong. The division signals the relative balance between politicians and the respective min­ istries. Strong zoku (agriculture, construction, and transportation) have consid­ erable influence over their respective ministry. With respect to the MoF, however, the zoku are generally considered weak, with little ability to dictate outcomes to the MoF. While often viewed as lobbyists, members of a zoku have a number of roles. They represent expertise that, to some degree, constitutes a counterweight to bureaucratic authority. Politicians with long careers often have more substantive expertise than bureaucrats who rotate in and out of various bureaus. They also act as intermediaries between industry and the bureaucracy. When industry can­ not get its way through the usual consensus-building process at the bureaucratic level, an appeal will be made to politicians in their zoku. In addition, they play influential roles in interministry conflicts. Whether top party officials, members of the bukai, or important individuals, MoF bureaucrats will consult these officials and keep them informed of all significant developments. The process includes bureaucratic promotions. The common perspective is that bureaucrats determine promotions and politicians rubber-stamp the decisions. In fact, the whole process is laden with political considerations and subject to informal clearance with relevant politicians. The most influential member of the mainstream of the MoF will traditionally

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find a pretense to meet with a politician whose assent is required, including the Minister of Finance, the head of the relevant section of the bukai and any other member of a zoku deemed particularly influential. At the end of the conversation, possible promotions will be mentioned. To the extent that powerful Diet mem­ bers have a strong view or objection, it will become apparent in the informal process and will need to be considered. The result is that promotions are uncontroversial when announced because they have been precleared by politicians. The most notable, recent example of a promotion influenced by political con­ siderations occurred in connection with the elevation of Eisuke Sakakibara to International Vice Minister. Sakakibara had not fulfilled the usual preconditions for the post. Moreover, he was actively opposed by many in the MoF because of his outspoken nature and close connections to politicians. His appointment reflected an MoF desire to appease political interests. Rather than risk a contro­ versy with politicians, top officials within the Ministry saw to it that he received a promotion, despite the violation of bureaucratic norms in doing so. Similarly the non-promotion of Yoji Wakui in 1998 was influenced by polit­ ical considerations. As director general of the Budget Bureau, he was the heir apparent for administrative vice minister. He was also the most likely successor to Takeshi Komura, the vice minister forced to resign in early 1998. Nonethe­ less, LDP power brokers refused to acquiesce, ostensibly because of his receipt of a painting from Junichi Izui, an oil dealer who lavishly entertained bureau­ crats and politicians. The belief in the bureaucracy, however, was that the delay represented a sign of displeasure over his connections to Jiro Saito, the vice minister viewed as too close to opposition politicians. Decisions to leave the bureaucracy also can have a political dimension. When scandals in the bureaucracy surfaced in early 1998, Takeshi Komura, the ad­ ministrative vice minister, wanted to show penance by accepting a pay cut but otherwise holding on to his position. Prime Minister Hashimoto, who assumed the finance portfolio for a week after the Finance Minister, Mitsuzuka, resigned, ordered him to resign, which he did. Thus, the appearance of voluntary departure was really a political dismissal. Political influence over promotions does not end with personnel decisions. Influential politicians also have a say in retirement posts. They will be told in advance and have an opportunity to influence all important amakudari positions. These will not, therefore, be given to retiring bureaucrats deemed unacceptable to the LDP. Jiro Saito, the powerful vice minister who negotiated with Ozawa during the brief period the LDP remained out of power, found himself in the hinterland, with no retirement position commensurate with his last MoF post. Rather than become head of a government-owned financial institution, he was appointed adviser to the Institute of Fiscal and Monetary Policy, an MoFcontrolled think tank. Despite his power and rank within the MoF, he found himself affiliated with an organization run by lower-ranking bureaucrats. Nor would he obtain a .more appropriate position until antagonism within the LDP dissipated.

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With top administrative and retirement positions cleared by politicians, bu­ reaucrats know that actions antagonistic toward influential politicians or impor­ tant interest groups can permanently damage a career. At the same time, good relations with politicians, to the extent that they improve effectiveness and are not too overt, can enhance a career. INFLUENCING THE BUDGET Political influence over the activities of the MoF is clearest and most pro­ nounced in connection with the annual budget process. Although budget nego­ tiations between the MoF and other ministries or agencies take place in the fall, political involvement occurs earlier. For one thing, politicians will seek to in­ fluence the draft budget sent to the ministries at the end of August. For another, success in obtaining approval of a particular item to some degree requires a display of commitment and effort, a continuous process. Politicians play a role throughout the process but particularly at several critical stages. They lobby respective ministries to include a desired project in their budget. In doing so, they act on behalf of key constituencies or important local governments. Thereafter, they beseech the Budget Bureau in an effort to obtain funding for the program. In this context, they are lobbyists for a particular ministry. If a project is deleted from the budget, LDP members have one last chance in intra-party negotiations to decide which projects will be resurrected and funded. Spending proposals often originate with a prefectural government, although they can also emanate directly from a particular ministry. Whatever the source, proponents know that they will need political support to ensure eventual ap­ proval. Given the pressure for new projects, bureaucrats in the Budget Bureau have little reason to permit inclusion unless they are accompanied by a sufficient demonstration of support from influential politicians. In the case of a project arising from the prefectures, local officials will seek support from their representatives in the Diet. Even opposition politicians find themselves receiving requests from local governments to intercede with the bu­ reaucracy. Support initially takes the shape of lobbying the respective ministry to include the desired project in its budget. Diet members introduce local offi­ cials to bureaucrats within the relevant ministry. All politicians make introduc­ tions, although those made by the LDP are the ones that matter the most. Efforts to get a project into the budget may involve considerable personal effort by a Diet member. Politicians may make a pilgrimage to the office of the relevant bureaucrat or engage in after-hours socializing. In effect the politician must, through direct effort, telegraph the seriousness of the request. Early dis­ plays are crucial. If the Ministry of Construction, Transportation or Agriculture does not approve the matter, there will be no opportunity to lobby the MoF. The ministries receive numerous proposals from politicians. Not all will be accepted. The identity of the politician, the extent of the efforts, and the merits

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of the proposal must be weighed. Moreover, politicians seeking influence must also demonstrate a certain degree of commitment to the particular ministry. A ministry expects a politician to support its entire budget, with an understanding that the Diet member has primary interest in projects affecting his or her district. In general, bureaucrats pay little attention to the spending interests of oppo­ sition party members. This was not always the case. Before 1993, the LDP could afford to be magnanimous and allow some projects supported by opposition parties into the budget. Doing so reduced political conflict and gave the oppo­ sition a greater stake in the existing system, at marginal cost to the LDP. With the new political circumstances, however, the dynamics changed. The opposition has some prospect of controlling the government. The LDP is, therefore, loathe to allow opposition parties to demonstrate their effectiveness, particularly by influencing the budget to benefit their electoral districts. Items sought by opposition politicians now have little prospect of appearing in the final budget. Once an item makes it into the particular ministry’s budget, efforts shift to influencing the Budget Bureau. In general, politicians in the LDP cannot simply demand that the Budget Bureau include funding for a particular project. Instead, they must build support for a matter. They may form a study group or bring the matter directly to the relevant subsection of the Policy Research Council. Even a minister in the Cabinet will sometimes seek approval of the PRC before trying to add a significant project to the budget. In lobbying the MoF, politicians know that the wrong argument with the Budget Bureau is to indicate that a particular ministry desired the project. In­ stead, the most effective approach promotes the importance of the project to constituencies in their electoral districts and to their reelection. At the same time, ministries know that, absent strong political support, new projects will receive little attention from the deputy budget examiner in the MoF. As long as the proposed budget has not been released, the meetings between bureaucrats and politicians involve an understood set of parameters. Politicians do not ask about specific projects, particularly whether they have been included in the budget. Nor do budget examiners provide the specifics; they describe MoF plans in general terms, without stating the precise funding amount or dis­ closing a specific funding decision. Shadowdancing notwithstanding, politicians telegraph their particular interests and bureaucrats provide some guidance, albeit subtle, on what will happen. In December, a proposed budget is submitted to the Cabinet. Projects that were inserted in a ministry budget and survived the Budget Bureau’s vetting process will almost certainly be included in the final version approved by the Diet. The most effective politicians, therefore, are those who can prevail upon the bureaucracy to accept their views, with cooperation and consensus the most valuable attributes. With the budget in the hands of the Cabinet, ministries know that they have a final opportunity to obtain changes before final approval. Success will again

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depend upon the political influence that a ministry can muster. Sometimes re­ ferred to as “ revival” negotiations, ministries seeking to reinstate budget items can make one more appeal to supporters in the Diet. Anticipating last-minute, inevitable political pressure, the Budget Bureau maintains a “ secret fund,” or kakushi zaigen. In effect, the bureau hides funds in the budget so that they can be reallocated to meet inevitable last-minute political demands. During the revival process, two opportunities exist to save a project. Nego­ tiations and compromise take place between the Finance Minister, representing the Budget Bureau, and the relevant minister, as spokesperson for his or her ministry. Those still dissatisfied with the result have an additional chance. Ne­ gotiations between the finance minister and the three top party officials will decide all unresolved issues.7 In these negotiations, the Finance Minister represents the government. The party secretary, the chairman of the Policy Research Council, and the chairman of the General Council represent the political interests of the LDP. Talks among these individuals will hash out any remaining controversy or disagreements over spending. The Prime Minister/party president also has considerable interest in the out­ come of the negotiations and the agreed-upon spending priorities. Given the controversial nature of the negotiations, however, the Prime Minister keeps some distance from the process and does not overtly take sides. His views, therefore, are conveyed in a more subtle, behind-the-scenes fashion. Usually he “ hides behind” the finance minister. The outcome of the final budget negotiations and the balance between the interests of the party and those of the government depend upon the relative strength of the particular individuals involved. Most often, but not always, the final decision is made by the Finance Minister, although with the expectation that he or she has taken party views into account. In the revival negotiations, politicians rank items deleted from the budget in order of importance. Some are designated as matters of extreme political im­ portance or maru sei. On these matters bureaucrats have no choice. Once the political process has been completed, the budget is returned to the MoF for one final round of analysis and negotiation. With important political items reinserted, the budget is finished. It is then submitted to the Diet, which traditionally adopts the budget without amendment, rendering the final step a formality. CONCLUSION Whether on legislative reform or budgetary matters, bureaucrats and politi­ cians communicate constantly. The traditional lack of legislative changes to the budget submitted to the Diet or legislation written by bureaucrats does not, therefore, mean an absence of political influence or demonstrate bureaucratic power, common misunderstandings. Instead, extensive political involvement oc­ curred, but at earlier stages.

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The system of influence and communication means that politicians keep closer observation on the decisions of bureaucrats than ordinarily accepted. Moreover, bureaucrats are powerless to act in the face of strong political objection. Poli­ ticians stopped MoF efforts to toughen bank disclosure standards in the early 1980s, to more rapidly remove barriers in the financial system, and to make farm banks pay more in the bailout of the jusen in 1996. Similarly, the budget process involves a relentless process of political inter­ action with bureaucrats. It benefits Diet members who have strong connections with the bureaucracy. Politicians, therefore, spend a considerable part of their careers developing contacts in a particular bureaucracy. In doing so, they in­ crease their influence, particularly in the context of the budget process. The budget process, therefore, explains a great deal about politicalbureaucratic relationships. Confrontational approaches may gamer public atten­ tion and notoriety but they do little to build influence. When budget season returns, those politicians will find bureaucrats less responsive. It also suggests that politicians have ready avenues for influencing bureau­ crats. Specific expenditures can usually be explained by political considerations rather than judgments by officials in the Budget Bureau. To the extent that policies reflect individual, rather than national, interests, the explanation rests at the political rather than bureaucratic level. Reform will ultimately be necessary. The reason is not, however, an omnip­ otent bureaucracy, untethered by political control. The real reason is to end political influence without responsibility. While politicians succeed in imposing their priorities on the budget process, they typically do so in a subtle, secretive way. Making the budget process more transparent would make much clearer to the voting public the relationship between politicians and spending priorities. Clar­ ifying responsibility in turn would weaken the system of vested interests that now permeates the budget. Politicians would no longer be able to hide behind the bureaucracy but would have to justify to the public the reasons for inefficient and outdated spending priorities. Changes in the Budget Bureau’s approach will also, however, be necessary. With most specific spending decisions made by each particular ministry, the bureau has already become irrelevant to much of the budget formulation process. To remain relevant, the bureau will need to develop reforms that result in in­ creased qualitative analysis of the budget. Such an approach may lead to far more rational spending patterns. At the very least, however, it will result in the identification of expenditures that can be reallocated by politicians to more ap­ propriate programs. Refocusing the bureau will, however, require substantial change in bureaucratic practices.

CHAPTER 13

The F o rm s of Political Intervention: C ooperation, C o n sen su s an d Conflict

The myth of bureaucratic power and absence of political accountability can be challenged simply by examining the annual budget process. Political consider­ ations permeate the process. Nor is the myth consistent with historical patterns of interaction between powerful politicians and the Ministry of Finance. Influ­ ential prime ministers often had close relationships with the MoF and succeeded in getting their desired policies implemented. The most successful have typically served as finance minister before becom­ ing prime minister. They have used the opportunity to cultivate contacts and create relationships with bureaucrats that proved invaluable later in their political careers. The MoF, therefore, often contained something approaching a fifth col­ umn ready to support a particular politician’s goals. In other cases, however, strong prime ministers have had few allies within the MoF. They have nonetheless succeeded in forcing upon bureaucrats policies they deemed important. In truth, when confronted by a determined politician not consumed by internal squabbles within the LDP, the MoF had limited room to resist. Put another way, difficulties in controlling the MoF could usually be traced to internal weaknesses in the LDP rather than the power of bureaucrats. Yasuhiro Nakasone represented a good example of someone without a par­ ticularly strong network within the MoF. He started his career in the Ministry of Home Affairs, the MoF’s principal bureaucratic rival, and never served as finance minister before becoming prime minister. Nonetheless, when he wanted to increase defense spending over the MoF’s objection, the Budget Bureau had little choice. With the defense budget having become “maru sei,” the bureau acceded to the extraordinary increases. The methods of achieving policy objectives have varied. No prime minister had more influence within the MoF than Hayato Ikeda. A former director general

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of the Tax Bureau and administrative vice minister, Ikeda developed within the MoF a powerful faction that supported his policy initiatives. Thus, when the time came to jettison the MoF’s practice of conservative finances in favor of expansionary budgets, the Ministry turned on the proverbial dime and adopted the new policy. Kakuei Tanaka also succeeded in getting his way with the MoF. Like Ikeda, he had followers within the Ministry, some developed during his earlier tenure as finance minister. Mostly, however, he dominated the bureaucracy the same way he did politics— with force of personality and a willingness to reward sup­ porters and penalize opponents. When Tanaka wanted the budget increased sub­ stantially, once again the MoF fell into line. Takeshita represented another politician with strong ties to the MoF. He had served as finance minister and had built up powerful connections in the Ministry. In some respects, he was also heir to the influence developed by Tanaka. Tak­ eshita was the politician responsible for obtaining adoption of the consumption tax, something deemed critical by the MoF. Takeshita remains the politician with the most influence over the MoF and is still consulted on all critical or controversial matters. Not all politicians who tried to bring the MoF under greater political control succeeded. Most recently, Masayoshi Takemura, finance minister under Tomiichi Murayama, brought a more confrontational approach to relations with the MoF. Unlike Ikeda, he lacked the fifth column within the Ministry. Unlike Tanaka, he lacked the firm political base needed to give his orders unassailable credibility. His tenure as finance minister was a disaster and all but cost him his political career. HAYATO IKEDA Hayato Ikeda had a long career in the MoF, punctuated and enhanced by the war and the occupation. He joined the Ministry in 1924 after graduating from the University of Kyoto. Not a Todai graduate, he remained outside the main­ stream of the MoF and was destined to have limited advancement in the Min­ istry’s hierarchy. Indeed, his first assignment was not to the sensitive positions in the Budget Bureau or Secretariat, but involved banking. He spent most of his career in various tax-related positions. In 1944, Ikeda became the director general of the Tokyo Financing Bureau, traditionally an exit position. His career path, however, shifted dramatically when Juichi Tsushima returned to the post of finance minister immediately after the war. Cognizant of Ikeda’s diplomatic skills, Tsushima promoted him to director general of the Tax Bureau. In a stroke of fortune, Ikeda next found himself in line to become adminis­ trative vice minister, a position that traditionally went to the Todai graduate heading the Budget Bureau. Ikeda got the job when the other members of his class were purged or demoted. In the postwar era, he would be the only non-

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Todai graduate to obtain the rank of administrative vice minister. Appointed to the post by Tanzan Ishibashi, then finance minister, Ikeda remained vice minister for one year, from 1947-1948. Even in the unusual conditions of the postwar period, his rise to prominence was startling. While in the MoF, Ikeda came to the attention of Shigeru Yoshida, a former bureaucrat from the Ministry of Foreign Affairs who had risen, as a result of postwar exigencies, to prime minister. After stepping down as vice minister, Ikeda joined Yoshida’s faction and a year later was elected to the Diet. A month after entering the body, Yoshida appointed him finance minister. As Yoshida faded from the scene, Ikeda became the heir apparent. He also had the requisite experience, having served in a number of critical party and government positions. He was the secretary general of the Liberal Party, one of the precursors to the LDP. In 1957, he again became finance minister, this time under Nobusuke Kishi, and later minister of MITI. Ikeda was elevated to prime minister in 1960, serving until he left office in 1964 for health reasons. Ikeda was responsible for launching a whole cadre of MoF bureaucrats on political careers. Some represented followers from his days in the Tax Bureau, including Shigesaburo Maeo, who also served as director general of the bureau. Two future prime ministers, Kiichi Miyazawa and Masayoshi Ohira, served as Ikeda’s private secretary. He also, however, maintained strong allies within the bureaucracy itself. Ikeda developed a “ family” in the MoF. While he served as vice minister, Teiichiro Morinaga was kanbo cho, head of the Secretariat. Morinaga and Ikeda went to the same high school, Kumamoto Koko (Goko), the Fifth High School. Mor­ inaga would eventually rise to vice minister. His influence continued after leav­ ing the MoF, serving in a number of important posts including president of the Tokyo Stock Exchange and Governor of the Bank of Japan. Another critical figure, Shinichi Ishino, served as kanbo cho while Ikeda was finance minister. He had joined the MoF in 1935 and would eventually become vice minister and chairman of Taiyo Kobe Bank. The adherents of Morinaga and Ishino within the MoF became known as the “ Mori-Ishi” line and were considered the mainstream. Ikeda’s faction maintained influence through this line into the 1970s. Ikeda needed the influence to induce the MoF to shift policies. Having become prime minister in the aftermath of Kishi’s successful but divisive efforts to obtain a new security treaty with the United States, Ikeda wanted less contro­ versial issues to define his administration. The centerpiece was to be economic growth. Under the catchy phrase “ the income-doubling plan,” Ikeda subjugated almost all other policies to the goal of growth. To achieve his goal, Ikeda wanted expansionary budgets. The goal, however, required a dramatic change in the attitude of the Budget Bureau. The MoF had psychologically been under the sway of former finance minister Hisato Ichimada. Ichimada, a former governor of the Bank of Japan and a fiscal conser­ vative, had tried to fix the national budget at a predetermined ¥1 trillion.

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Ichimada had not been successful in imposing the cap but had instilled in the MoF a conservative attitude toward spending. Ikeda, however, succeeded in altering this attitude. Both Morinaga and Ishino supported Ikeda’s expansionary financial policies. The 1961 budget saw an in­ crease of 50% and the first use of ceilings by bureaucrats in the Budget Bureau. The days of fiscally conservative budgets were over, although not without some opposition within the MoF.

TAKEO FUKUDA A faction within the MoF that supported a particular politician or political faction was, in many respects, a unique experience. The MoF instead tended to maintain connections with all important power centers within the LDP. When Jiro Saito developed his own “ family” in the Ministry, the faction was built around mainstream ideas, without identification with a particular group of pol­ iticians. Saito’s faction supported those in power, something illustrated by the decision to first support the Hosokawa government and then the LDP once it returned to power. Divisions within the MoF like the Mori-Ishi line carried considerable risk. Too close an identification with a particular faction of the LDP would invite retribution from politicians whenever power shifted. Politicians could intervene in ministry affairs and interfere with promotions, elevating their allies. They also created what amounted to disaffected groups of officials within the bureauc­ racy. The group included those who either objected to the policies of the faction or felt their career was disadvantaged because they were not members. The concerns surfaced when Eisaku Sato succeeded Ikeda as prime minister. Not all politicians had been happy with Ikeda’s influence within the MoF. Some saw the authority as a threat. Others objected to the policies themselves. As prime minister, Sato wanted to reduce the authority of Ikeda’s faction within the Ministry. He had tried to do so when he served as finance minister in the Kishi government but with little success. To assist him with the task, Sato appointed Takeo Fukuda as finance minister. Fukuda was a shrewd choice. A former finance bureaucrat, he knew the MoF well. Despite his links to the Ministry, however, he had not been part of the Ikeda faction. He also had objectives similar to Sato’s. He wanted to weaken Ikeda’s support, both for political reasons and from concern over the fiscal policies of the former prime minister. A graduate from Todai, Fukuda entered the MoF in 1929. He served as di­ rector general of the Banking and Budget Bureaus, and was scheduled to become vice minister. His administrative career ended abruptly, however, as a result of the Showa Denko scandal. Tainted by the scandal, he would not receive the expected promotion. Not until the 1970s would another director general of the Budget Bureau be passed over for promotion to vice minister. Although ulti­

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mately cleared of any wrongdoing, Fukuda resigned from the Ministry and en­ tered politics. Reducing Ikeda’s influence meant contending with the Mori-Ishi line, which dominated the high-ranking positions within the MoF. Fukuda, therefore, had to develop his own band of supporters not connected to the Mori-Ishi line. They were not difficult to find. Some within the MoF were unhappy with the influence of the Mori-Ishi line, particularly the expansionary policies promoted by the faction. These included Ichiro Sato and Kotaro Murakami, both of whom eventually became directors general of the Budget Bureau and administrative vice minis­ ters. Less supportive of Sato-Fukuda and more opposed to the MoF mainstream, they resented the lack of political neutrality of the Mori-Ishi line. They also opposed the high-growth policies. Fukuda also tried, however, to develop his own allies within the MoF. Satoshi Sumita represented perhaps the most notable example. Sumita and Fukuda came from the same prefecture. Sumita had ties to one of Fukuda’s strongest sup­ porters, the president of Takasaki Paper. Moreover, Fukuda knew Sumita from his days in the MoF. Fukuda used his power as finance minister to assist Sumita’s career. After becoming finance minister in 1965, he tried to have Sumita promoted to the position of director general of the Banking Bureau, even though Sumita had no banking experience. Fukuda did not get what he wanted right away but Sumita eventually obtained the position. Three years later, Fukuda would again serve as finance minister, promoting Sumita to administrative vice minister, a rare, non-mainstream promotion and only the third time in the postwar era that some­ one from the Banking Bureau became vice minister. It would be almost 20 years before another such promotion would occur. Sumita, in turn, used his authority to weaken support within the MoF for other politicians. In particular, he sought to limit the influence of the Mori-Ishi line. He gave a number of bureaucrats unattractive promotions, which essentially forced them out of the MoF. Sumita, therefore, was closely identified with Fu­ kuda, a characterization that would haunt him later. Rumors in the financial markets suggested that Sumita was slated to become governor of the Bank of Japan in 1979, when Morinaga prepared to step down. His close association with Fukuda, however, made the appointment a practical impossibility. Ohira had just won a bruising battle to become prime minister, defeating Fukuda. He had no interest in promoting a bureaucrat identified with his political enemy. A supporter of Ikeda, Ohira also remembered the treatment of the Mori-Ishi faction by Fukuda and Sumita. To block Sumita’s advancement, Ohira instead appointed Haruo Maekawa, a career official from the central bank.1 Sumita had to settle for the post of vice governor. The series of appointments resulted in a serious bureaucratic slight. When Sumita had served as governor of the Export-Import Bank, Maekawa had been the vice governor. Ohira’s decisions, therefore, placed Sumita in a position

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where he had to answer to his prior subordinate. This reversal of hierarchy was unusual and embarrassing. Only in 1984 did Sumita finally become governor of the central bank. With his background in the MoF and supporters in the bureaucracy, Fukuda had the ability to sway the Ministry. Viewed warily, even with dislike, bureau­ crats had to respond to his orders. During his second term as Finance Minister, Fukuda sought to restore sound fiscal policies after the excesses of the early days of the Tanuka era and the reverberations of the oil crisis. When he received a budget he deemed inconsistent with these goals, Fukuda simply ordered bu­ reaucrats in the Budget Bureau to reopen negotiations and cut spending further, which they did.

KAKUEI TANAKA Kakuei Tanaka may have been the most powerful politician in postwar Japan. A self-made man with no university education, he entered politics during the occupation. Tanaka had an encyclopedic mind, including a prodigious ability to remember names. He also knew how to raise the kinds of funds that provided influence within the LDP. Before becoming prime minister, Tanaka served in a number of important cabinet posts, including finance from 1962-1965 and MITI from 1971-1972. His three years at the MoF made him familiar to bureaucrats and provided a sustained opportunity to develop influence. When Sato stepped down as prime minister, Tanaka brushed aside the heir apparent, Takeo Fukuda, and became the youngest postwar prime minister up until that time. Tanaka dominated the MoF like no other politician. He did so, however, in a way very different from Ikeda. He did not have a faction within the MoF, although there were supporters. Tanaka demanded change and personally pres­ sured bureaucrats until he obtained the desired results. He had a less awe-struck attitude about the bureaucracy. Bureaucrats were not to make policies, only to execute the ones determined by politicians. He even indicated in a speech that the prime minister should approve promotions within the bureaucracy of director or higher. Not surprisingly, Tanaka had a habit of not always respecting the bureaucratic chain of command but instead picking up the phone and calling lower-level officials or bringing them to a meeting. His concern was not hierarchy but effectiveness. During his political career, Tanaka assiduously maintained his contacts within the bureaucracy. At the MoF, he had strong contacts with Fumio Takagi. The careers of the two intersected on a number of occasions. When Takagi fell into disfavor with the reigning vice minister, Kotaro Murakami, he sought advice from Tanaka on whether to resign. Later, Takagi worked closely with Tanaka, then secretary general of the LDP, on legislation relating to the Automobile

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Weight Tax. Tanaka’s support would ultimately prove critical to Takagi’s rise to administrative vice minister. Tanaka became prime minister in July 1972 at the age of 54, and served until December 1974, when he was ousted by scandal. During his first year in office, Tanaka’s most significant economic goal was an expansionary budget. With the fiscal year not yet over, he demanded a supplemental budget and got the MoF to agree to spending double what the bureaucracy had intended. He continued his drive for expansionary budgets in the next fiscal year. He held a face-to-face meeting with Hideyuki Aizawa, the director general of the Budget Bureau and Osamu Hashiguchi, director general of the Treasury Bureau, insisting that they not be conservative with spending decisions, code words for an expansionary budget. Prime ministers did not always apply such direct pres­ sure. Tanaka did. Not content simply to induce expansionary budgets, Tanaka also interfered in personnel decisions. The most obvious example occurred in connection with the promotion to vice minister in 1974. The incident arose out of the broader power struggle between Tanaka and Fukuda. With Sato ready to step down as prime minister, the expectation was that Fukuda, his chief lieutenant, would get the post. Tanaka, however, had other ideas. In what later became dubbed the KakuFuku Wars, a titanic struggle took place between the two pretenders. With Fu­ kuda unable to compete with Tanaka’s influence and financing, Tanaka emerged victorious. The struggle played out at the bureaucratic level. By all rights, the director general of the Budget Bureau, Osamu Hashiguchi, expected the post of vice minister. Indeed, no head of the bureau had been passed over since Fukuda himself became embroiled in the Showa Denko scandal in the 1940s. Hashi­ guchi, however, had close ties to Fukuda, something now a liability. With the need to obtain political acceptance of promotions by Tanaka and his faction, Hashiguchi’s ascension was unacceptable. Instead the vice minister would be none other than Fumio Takagi, the director general of the Tax Bureau. When the dust settled, Takagi had been promoted and Hashiguchi was shunted off to become the first vice minister of the National Land Agency. In the post­ occupation era, Takagi was only the third person appointed vice minister from the Tax Bureau, a decidedly rare event. Little discussed, the struggle over the promotion turned on political consid­ erations and represented an extraordinary departure from the MoF’s system of promotions. While vice ministers occasionally came out of the Tax Bureau, they typically received the position as a short-term reward and did not displace a director general of the Budget Bureau. Hashiguchi became the only Budget Bureau director since the occupation not to be promoted and the only one in the postwar era denied the position for overtly political reasons. Tanaka’s influence ultimately proved to be a mixed blessing. He unquestion­ ably manipulated the bureaucracy to achieve what he wanted, primarily increases in government spending. His expansionary policies, however, occurred right

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before the first oil crisis in 1973. The next year, Japan witnessed negative ec­ onomic growth and high inflation. Even after the country recovered, growth rates halved. Tanaka, therefore, influenced the bureaucracy but, in large part because of bad timing, contributed to economic havoc and massive deficit spending that began in the mid-1970s. It would take the bureaucrats most of the next 15 years to get government spending back under control. Only in 1990 did the MoF succeed in balancing the budget and avoiding the issuance of any additional deficit bonds. Not surprisingly, therefore, officials within the MoF came to view the period of Tanaka’s influence as a time of weak bureaucratic leadership, with MoF officials incapable of resisting misguided political initiatives. In fact, however, during Tanaka’s reign as prime minister, many bureaucrats within the MoF held him in awe. He was effective, decisive and skilled. Only later, when the economic consequences became clear, would the more negative view become the prevailing characterization of his interaction with the bureauc­ racy. MASAYOSHI TAKEMURA Masayoshi Takemura, the first finance minister under Tomiichi Murayama, represents another model of interaction with the MoF. His inclusion does not fit neatly with the other case studies. Takemura did not hold the position as a stepping stone to prime minister; nor was he a power broker within the ruling party. He was the head of a small coalition partner, Sakigake. A former bureaucrat who entered politics, Takemura began his professional career in the Home Affairs Ministry in 1962. Typical of the Home Affairs path to political success, he left the Ministry and was elected mayor of Youkaichi City, then governor of Shiga Prefecture. He entered the Diet in 1986 and became president of Sakigake in 1993. He came to power with the reformist Hosokawa government, which placed bureaucratic reform at the center of its political agenda. Takemura served as chief cabinet secretary. In that position, he had unsatisfactory interaction with the MoF, particularly over plans to increase the consumption tax. When the government fell from power, Takemura emerged as the finance minister in the LDP-dominated government headed by Socialist Prime Minister Murayama. Blunt, pragmatic, outspoken, Takemura did not represent the traditional fi­ nance minister. He had some of the requisite connections and education. A graduate of Todai and a former bureaucrat, Takemura seemed to know how to deal with administrative matters. At the same time, however, Home Affairs represented the MoF’s bureaucratic archrival. Unlike most past officeholders, Takemura did not use his tenure as finance minister to build allies within the bureaucracy. He lacked the contacts of an Ikeda and the political savvy of a Tanaka. Instead, he tended to deal with the MoF in a direct, even confrontational fashion. As the politician in charge of the

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Ministry, Takemura expected to get his way. The result was disastrous. He may not have been, in the words of Euromoney,2 the worst finance minister, but he was ineffective. Takemura’s approach arose in part from his basic personality. It also arose from his treatment (or mistreatment) at the hands of the MoF while he was in the Hosokawa government. The coalition government had presented the MoF with a new set of circumstances. For the first time since the 1940s, the Ministry had to deal with a government not exclusively run by the familiar power brokers within the LDP or one of its predecessors. Notwithstanding these new dynamics, Jiro Saito conducted negotiations over the consumption tax with familiar people who had left the LDP, particularly Ichiro Ozawa, the party secretary. The ap­ proach seemed successful. Dubbed the “ national welfare tax,” Hosokawa an­ nounced it late one night, with little advance warning either to the public or his coalition partners. Takemura only learned of the decision a short time before the public announcement. Sakigake and the other parties were deliberately kept out of the information flow. The process proved to be a political disaster. Hosokawa’s attempt to introduce the increase foundered when both Sakigake and the Socialists vehemently op­ posed the efforts. The opposition was motivated more by anger at the process than the resulting policy. When both parties returned to power with the LDP later the same year, one of the first orders of business was to approve an increase in the consumption tax. After the coalition government fell, Sakigake returned with the LDP. Saki­ gake’s votes were not necessary for the LDP to remain in power, but had an important symbolic value that transcended the party’s relatively small size. Sak­ igake was a reformist party and the LDP needed a reformist stamp of approval on its government. The accentuated importance of his party, therefore, gave Takemura the right to insist on a significant post. He became minister of finance, a post that provided an opportunity to settle a score with the bureaucrats in the MoF. Takemura made it a point to disagree publicly with the MoF. He insisted on a reduction in the planned increase in defense spending. He promoted a plan by Socialist Prime Minister Murayama to eliminate a number of public corpora­ tions, particularly those controlled by the MoF. When bureaucrats had to provide briefings, he insisted that they be high-ranking rather than the most knowledge­ able. Most notably, Takemura took advantage of a scandal within the Ministry to humble the bureaucracy and oust his nemesis, Jiro Saito. Saito had been re­ sponsible for the negotiations with the Hosokawa coalition over the consumption tax, the same negotiations that had excluded, among others, Takemura. Looking for a chance to punish the main offender, Takemura got the oppor­ tunity when a scandal broke over excessive entertainment of MoF officials by property speculators. Politicians, including Ryutaro Hashimoto, clamored for Saito’s removal. Aware of his weakening position, Saito resigned a month after

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being reprimanded, a few months before his term expired. Ironically, Saito, an austere individual, generally avoided the entertaining and golf outings, the very behavior that brought an early end to his career. Takemura also interfered with the system of promotions within the MoF. The director general of the International Finance Bureau was slated to be Isao Ku­ bota. Instead, however, Takemura intervened and insisted that the position go to Eisuke Sakakibara. Sakakibara was not a mainstream candidate and, in or­ dinary times, would have had no chance to become director general. Nonethe­ less, he received the post, with Kubota consigned to the far less important Bureau of Customs and Tariffs. Yet most of Takemura’s victories were either cosmetic or superficial. The MoF got what it wanted the most, an increase in the consumption tax. Moreover, as finance minister, Takemura had little room to object. Sakigake and the So­ cialists could take the position that they prevailed on the MoF to reduce the size of the increase and to delay implementation. Nonetheless, there was no escaping the success of the bureaucracy-inspired policy. In other instances, the MoF managed to block reform efforts promoted by Takemura, causing him political embarrassment. Murayama promised to elimi­ nate 10% of all public corporations, a call supported by Takemura. Hobbled by bureaucratic opposition, however, the plan went nowhere. In a last-ditch effort, Takemura announced the merger of the Export-Import Bank and the Overseas Economic Cooperation Fund. Combining the two agencies promised few new efficiencies and made little logistical sense. The main effect of the merger seemed to be the elimination of one “ reserved seat” for retiring MoF officials, since both organizations were typically headed by former vice ministers. The plan was widely criticized and contributed to the appearance of ineffectiveness. Moreover, the merger was not due to take place until 1999, giving the MoF plenty of time to get the damage undone. Takemura also suffered from unfortunate timing, having been in office when the $1.1 billion in trading losses by Daiwa Bank became public. The problem seemed to be a straightforward financial scandal until it was learned that the MoF had become aware of the losses six weeks before U.S. regulatory author­ ities were informed. Takemura had to make a painful phone call to Treasury Secretary Rubin in Washington, in what would subsequently be characterized as an apology. The incident helped demonstrate how little actual control Take­ mura exercised over bureaucrats. The one time Takemura supported the MoF proved to be the most politically disastrous. He approved the Ministry’s efforts to obtain public funding to bail out the jusen or housing loan companies. When outrage developed over the funding plan, Takemura received much of the political blame. Rumors circulated that he wanted Nishimura, the director general of the Banking Bureau, to resign to take responsibility for the controversy, with the administrative vice minister quitting instead.

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Even his biggest success was not his own. Forcing out Saito, the vice minister, represented a humiliating lesson for the MoF. He only succeeded, however, because Saito had, through his close working relationship with Ozawa, alienated the LDP. In effect, therefore, Takemura did the bidding of the Hashimoto gov­ ernment. How well did Takemura do? Euromoney branded him, perhaps unfairly, the “ Worst Finance Minister.” Moreover, in elections following his elevation to finance minister, the judgment of voters was negative. Sakigake won only three seats in the upper house election held on July 23, 1995, forcing Takemura to step down as finance minister. In the Diet elections in October 1996, Sakigake’s membership fell to two.3 Takemura’s experience and the devastation to his career did not go unnoticed by other politicians. When Ryutaro Hashimoto replaced Murayama as prime minister, he needed a new finance minister. Notwithstanding the historical im­ portance of the position to ambitious politicians, Hashimoto had a hard time finding anyone to assume the role. In the end, he had to turn to Wataru Kubo, a member of the Socialist Party, someone with no discemable expertise on financial matters and no likelihood of ever serving as prime minister.4 At the same time, however, Takemura’s travails benefited the LDP, once again showing how bureaucratic behavior aided the most powerful politicians. His party had initially been a valuable addition to the coalition. With the LDP and the Socialists representing status quo political forces, Sakigake had been the one true reform party to enter the coalition. By the end of Takemura’s reign at Finance, however, the reformist reputation was gone. The LDP eventually ex­ pected to dominate the government and control all top posts. Anything that weakened Sakigake, therefore, was likely to benefit the LDP. In some respects, Takemura’s problems reflected his weakness within the coalition. Prior politicians had demonstrated that it was possible to dictate to the MoF and succeed. The circumstances, however, had to be right, with suf­ ficient political influence a minimum requirement. Takemura lacked this essen­ tial element. On the other hand, Takemura illustrated the inherent risks associated with a confrontational approach. Takemura’s tenure was generally ineffective. He also found himself subject to blame and embarrassment. Confrontation at the expense of effectiveness won few plaudits or electoral rewards. THE RESULTS The myth of bureaucratic control of politicians has never been particularly accurate. In the postwar era, politicians have regularly insisted on policy changes within the bureaucracy and usually gotten them. Results have varied with the personalities in power. Strong prime ministers have done better than weak ones. That has had less to do with inherent bureaucratic power than internal weak­ nesses within the LDP.

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Confrontation with the MoF and public attempts at bureaucratic humiliation, in contrast, did not work, as Takemura’s efforts demonstrated. Takemura did not understand the MoF well enough to know how to confront the bureaucracy successfully.5 The MoF was able to parry any serious attempt to erode its pow­ ers. Moreover, in general, the MoF could still count on the support of the LDP. Saito’s dismissal was expected since he had worked too closely with the Hosokawa government. Beyond that, the LDP had more interest in working with rather than against the MoF.

CHAPTER 14

The N ational In terest: Politicians, B u re a u c ra ts and th e C onsum ption Tax

That Japanese politicians lack leadership qualities represents a large part of the myth about bureaucratic power. Because politicians have abdicated their re­ sponsibilities, the gap has, by default, been filled by bureaucrats. In fact, how­ ever, that is an inaccurate view. In addition to considerable, subtle influence, politicians have demonstrated true capacity to lead on numerous occasions, even when it might end their political careers. Some examples are well known. Nobusuke Kishi, for example, renegotiated the security treaty with the U.S., creating a firmer basis for relations between the two countries. The effort caused enormous dissention within Japan, including near-riots. The controversy surrounding the treaty ultimately forced Kishi to resign as prime minister. Others, however, were more subtle. A recent example of politicians who led, and the symbiotic interaction between bureaucrats and politicians, occurred in connection with the introduction of the consumption tax. As might be expected, introduction proved intensely unpopular. Already highly taxed, most Japanese had little sympathy for a surcharge on goods purchased. Yet somehow the tax became law. Bureaucrats within the MoF created a basic plan and the politicians put it into practice. Moreover, the terms of the tax ultimately adopted were shaped more by the political process than bureaucratic vision. Both groups, however, participated in the effort, at great cost. The MoF was publicly pilloried by the press; the politicians were subjected to retribution at the ballot box. The tax was necessary; even in Japan, few argued otherwise. The existing tax system had become too dependent upon income taxes. Moreover, the need for additional flexibility in the tax system seemed relatively clear. Given the aging population, the country confronted burgeoning payments for social welfare pro­

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grams. With marginal rates already high, increases in income and corporate tax rates were not feasible. A consumption tax, therefore, represented a rational alternative. Adoption of a consumption tax had, by the late 1970s, become a bureaucratic imperative. Originally it was designed as a fundamental reform of the tax sys­ tem, but the MoF became consumed by a more immediate purpose— the need to balance the budget. The MoF saw the tax as a critical device designed to raise the revenues needed to pay for the deficits that had exploded after the first oil crisis. Primary responsibility within the MoF fell to the Tax Bureau. So serious was the bureaucratic effort that it entailed an unprecedented shift of personnel within the Ministry. Officials on the fast track in the Budget Bureau suddenly found themselves detailed to Tax. The Ministry assigned to the task those persons considered particularly able and with the best political contacts. At a time when any number of other crises could have used the best and the brightest within the MoF, it was indicative of the importance of the matter that they were as­ signed to the consumption tax issue. Equally Herculean were the political efforts to obtain passage. Dubbed the “ prime minister killer,” efforts to enact or raise the consumption tax directly contributed to the fall of at least four prime ministers. At every stage, public outrage over the tax proposal appeared. The easiest political decision would have been to put off the issue until the crisis was more imminent. In fact, politicians in the LDP worked resolutely toward passage, despite the inevitable electoral consequences. Adoption of the tax and a subsequent increase also had to occur in a rapidly evolving political climate. In an era of one-party rule, the MoF had only to convince a small group of ruling politicians to accept the wisdom of a con­ sumption tax, not an easy task but ultimately manageable. Specifically, that meant cutting a deal with the top party officials. In the 1990s, however, the shifting political situation made the MoF’s job more complex. Coalition partners, a viable opposition and the rank and file in the LDP all expected consideration. Adjusting to these realities did not come easily. The Ministry would pay a heavy price for the failure to better understand the new dynamics, both in the form of public scorn and political intervention. Once again, however, the MoF learned. The parties and politicians that defeated early efforts at raising the consumption tax became the very ones to propose and adopt it a year later. THE NEED FOR TAX REFORM Until the 1980s, Japan had a tax structure that strongly resembled the one in the United States, no real surprise since the system was put in place during the occupation. Under the system, most tax revenues came from corporate and in­ come taxes, with-the top brackets bordering on being confiscatory. With indi­ vidual rates already high, the system had little elasticity and would not tolerate

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additional increases. Japan’s rapidly aging population and the need to fund wel­ fare programs made additional sources of revenue critical. The problem was not academic. By some estimates, more than a quarter of Japan’s population would be over 65 by the year 2025, the highest proportion among all industrial nations. Reliance on income taxes also resulted in an unequal burden within Japanese society. Tax avoidance had become common among certain groups, particularly small businesses and farmers. In contrast, salarymen, who had taxes deducted by their employers, had a high rate of compliance. An indirect tax promised to broaden the base and ensure greater compliance among all segments of the population. A consumption tax would address these concerns. In effect a national sales tax, the consumption tax was not imposed on income but on the sale of goods and services. It could be raised to meet the revenue needs of an aging population and the tax would be difficult to avoid. The substantive merits notwithstanding, the real impetus was not fairness or gentrification, but a balanced budget. Rather than a revenue-neutral proposal that simply shifted taxes from direct to indirect, the MoF wanted a real increase in revenues to help pay for the deficits that had burgeoned after the first oil crisis. Bureaucrats and Budget Deficits Fiscal conservatism and the desire for a balanced budget amounted to an almost messianic fervor within the bureaucracy. The religion permeated the en­ tire budget process. The fiscally conservative approach represented an integral part of the training of MoF officials. It arose primarily out of the supposition that without the limits of a balanced budget, bureaucrats would have less ability to stop profligate politicians. In countering political demands for more pork barrel projects, the winning argument traditionally was that no funds existed to pay for them. In fact the MoF’s “ religion” had never been quite as dogmatic as some suggested. The MoF accepted far more expansionary budgets under Hayato Ikeda and, later, under Kakuei Tanaka. Although budgets increased, the one constant was that the government would not run a deficit. The MoF had an almost rabid opposition to the use of government debt to pay for any deficits. Budgets, therefore, had to balance. The Budget Bureau achieved the feat through conservative estimates of expected revenues, with supplemental budgets used to spend any excess. Even then, that did not mean the MoF opposed expansionary policies. In fact, the Ministry could be downright pro-growth. The goal simply had to be achieved without resorting to deficit spending. During the 1980s, bureaucrats pressured the central bank into lowering interest rates to spur economic growth. Increased growth had the collateral benefit of bringing in more tax revenues, facilitating the goal of a balanced budget. Indeed, expansionary policies were favored as

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long as they did not involve deficit spending and greater discretion for politi­ cians. Even the “ constant” opposition to deficits was no constant. The system of balanced budgets had been premised upon the expectation of continued increase in tax revenues. As long as the economy continued to grow, corporate and individual income would climb, increasing tax revenues. Only with unexpected slowdowns and accompanying decreases in tax revenues did problems arise. That occurred in 1964 and it caught the MoF unprepared. The decline in growth coincided with an increase in spending resulting from the expansionary budgets put in place at the insistence of Ikeda. When tax forecasts did not keep pace with expected growth, the MoF responded in June 1965 by attempting to ratchet down expenses, imposing a 10% cut on all agencies. The approach, however, generated controversy. The Cabinet ultimately de­ cided to end the spending restrictions favored by the MoF, making a deficit and the issuance of bonds inevitable. Takeo Fukuda, who had replaced Tanaka as finance minister, first broached the idea of deficit bonds. Doing so, however, required an amendment to the Finance Law, something the Diet completed in 1965. For the first time since the occupation, public debt financing would be used to cover government deficits. The decision breached a post-occupation absolute within the MoF. Unsur­ prisingly, the MoF did not accept the decision with equanimity. The Ministry continued to impose spending restraints and produced only a small supplemen­ tary budget. Although the Cabinet had authorized the issuance of bonds in the summer of 1965, they were not actually sold until January 1966. The first dip into deficit spending was a small one, reflecting the relatively limited nature of the economic crisis. Still, the MoF had a new set of problems. The bonds had to be repaid. The game was no longer simply matching expen­ ditures with tax revenues but how to generate enough revenues to pay off past shortfalls. Any notion of a modest and containable deficit disappeared with the largescale government spending ordered by Tanaka in the early 1970s. When Tanaka became prime minister, he immediately insisted on an expansionary budget. He did so over the opposition of the administrative vice minister and the director general of the Budget Bureau, successfully browbeating the MoF into producing a budget that grew by almost 25%. The oil crisis exacerbated matters by causing a revenue shortfall. So did increases in social welfare programs. For the first time since the occupation, the country had to issue bonds to pay a shortfall in the general account. The postwar imperative opposing the use of bonds to pay government deficits was breached, with matters quickly spinning out of control. Total public bonds outstanding as a percentage of GDP jumped from 4.8% in 1971 to 12.9% in 1976 to 25% in 1979. The percentage would peak in 1986, at 42.7%. Any appearance of fiscal discipline was gone.

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Controlling the Deficit The MoF’s mistake, clear with the benefit of hindsight, was having placed too much emphasis on the absolute opposition to the use of deficit bonds. Once politicians succeeded in overturning the bureaucratic Maginot Line, the Ministry had no fallback. The ban on bonds had been the primary limit on government spending. With that gone, the deficit spiraled out of control. Having failed to plan for the inevitability, the MoF would spend much of the next 15 years trying to get spending back under control and return the budget to balance. In attempting to eliminate the deficit, the MoF would ultimately seek both enhanced tax revenues and reduced government expenditures. Specifically, the Ministry adopted a three-prong approach, including the privatization of gov­ ernment-owned corporations, tax increases and reductions in government spend­ ing. Moreover, the MoF was prepared to put them in place gradually, taking a decade or more to achieve the final result of a balanced budget. Reducing expenses as the principal method of balancing the budget was im­ possible. The reductions would have been large and likely to have engendered opposition, with ministries beseeching their political allies. At best, the MoF could only impose reductions uniformly and gradually, building them into the budget ceiling imposed each year. In the early 1980s, the Budget Bureau reduced the annual increases until eventually they disappeared completely, with one budget imposing real decreases. The austerity approach, however, did not save enough revenue. It applied only to general account expenditures, not total government expenses. Even as the Budget Bureau ratcheted down discretionary expenses, the costs of national health and servicing the national debt increased. Moreover, the efforts to reduce spending ultimately generated political opposition. LDP members would permit negative growth only for so long. The absence of increases provided little room for pork barrel projects and other largess. Subsequent budgets, therefore, tended to permit increases, albeit small ones. The other approach was to increase revenues. This did not simply mean rais­ ing taxes. In the 1980s, the fiscally conservative MoF sought, with singlemindedness, to promote growth. Growth would lead to increases in income, bracket creep, and higher tax revenues. The MoF favored the use of lower interest rates and pressured the Bank of Japan to cut them. The result was an economic bubble that helped accomplish the MoF’s short-term goal (the budget was balanced in 1990) but would make matters worse in the long term by contributing to a severe economic slowdown when the bubble was pierced. Revenues could be increased in other ways. It was no coincidence that the 1980s saw serious efforts to privatize government-owned corporations. Shares in Japan Tobacco and Salt, Japanese National Railways and Japan Telegraph and Telephone were sold to the public. The decision was made to do so even

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though privatization could eliminate a number of assured positions for retired Ministry officials. The main way to raise revenues, however, was to increase taxes. Tax reform took a number of different forms. The MoF tried and succeeded in increasing the tax base, although the process was not smooth. During the early 1980s, an attempt was made to introduce a national identification card in an effort to end tax evasion in connection with savings accounts. When that failed, the Tax Bureau succeeded in having the tax deduction for interest income repealed. The approach, however, did not raise enough revenue. Tax rates had to be increased. With already high rates on personal and corporate income, bureaucrats focused on a consumption tax. In seeking introduction of the tax, the MoF took the usual approach. Bureaucrats essentially engaged in back-office negotiations with key politicians. While the Ministry did succeed in having the tax imple­ mented, this occurred at a time when the political consequences of the unpopular step, though severe, were manageable. Whatever the LDP did, voters were not going to send to power the largest opposition party, the Socialists. As the political situation changed, however, the consequences of supporting such un­ popular measures would increase, making the MoF’s task that much more dif­ ficult. THE PRIME MINISTER KILLER The effort to implement a consumption tax alone raises substantial questions about the conventional view of Japanese prime ministers as weak and beholden to bureaucrats. The MoF’s goal of implementing a consumption tax could not have occurred without remarkable political support and involvement. Moreover, it was politicians who eventually crafted a compromise that most interest groups could accept. Without the willingness of politicians to develop and promote the endeavor, the MoF’s cherished goals would not have occurred. The issue was a nightmare for any politician. Prime ministers promoting the tax tended to see their careers cut short; parties responsible typically did poorly in subsequent elections. With the possible exception of Masayoshi Ohira, each Prime Minister who introduced a consumption tax (or increase) knew that he was taking a grave and obvious political risk. Yet politicians went forward anyway. Acceptance of the tax by politicians was never a foregone conclusion, even within the LDP. Some completely avoided the issue, publicly disavowing any intention to increase taxes. Others could not effectively sell the proposal to their own constituencies or party members. Success occurred only after strong-willed politicians convinced their own party and reluctant constituencies, then accepted their fate at the hands of the electorate. Their willingness to support the tax, despite the electoral consequences, oc­ curred in part because they saw it as necessary for Japan’s future. Politicians knew that, ultimately, Japan would need to confront the problem of paying for its aging population. They also knew that the government deficits could not

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continue indefinitely. In other words, for all the complaints about a leaderless Japan, these politicians demonstrated true political leadership, at least in con­ nection with this particular issue. Of course, support for the tax was not entirely altruistic. Increasing govern­ ment revenues also had the agreeable consequence of placing more funds at the disposal of politicians, to be redirected toward their favorite pork barrel public works programs. Moreover, in some instances, politicians agreed to a future introduction of the consumption tax (or an increase) in return for an immediate cut in income taxes. They would obtain the benefits while saddling their suc­ cessors with the obligation to pay for it. Nor did it mean that politicians avoided opportunities to minimize the con­ sequences of introducing the tax. Almost from the beginning, key constituencies were exempted. Indeed, with respect to small businesses, the tax ultimately allowed them to retain any revenues collected. Political realization that taxes would have to increase began following the explosion in deficit spending during the 1970s. Even Tanaka understood that government spending on such a grand scale could not go on forever, at least after the new economic realities ushered in by the first oil crisis. He appointed his old rival, Fukuda, as finance minister to handle the burgeoning deficit prob­ lem. Fukuda wanted to restrain spending and called for a reexamination of the proposed budget. Ironically, he had to force the approach on the Budget Bureau. Negotiations over the budget had been completed and the bureau had little in­ terest in disturbing the deals that had already been reached. The physical task of reopening negotiations also promised to overwhelm the staff of the bureau. Fukuda, however, had his mind made up. When MoF officials indicated that they had been able to cut growth to only 23%, Fukuda ordered them to return and do better. Spending continued to increase, particularly with foreign pressure on Japan to lead an international economic recovery. By the end of the 1970s, the need to get budget expenditures under control could no longer be ignored. Particularly in the second half of the decade, deficits had exploded, with Japan losing its reputation as the thrifty member of the industrial club. Even business leaders viewed spending as out of control, with the matter becoming a national emer­ gency. Circumstances seemed to dictate a tax increase. With income tax rates already too high, the consumption tax was the only realistic alternative. Over the next 15 years, five prime ministers would stake their careers on adoption of the tax, with four falling from office in large part because of their support. Masayoshi Ohira Masayoshi Ohira became Prime Minister in December 1978, ousting Fukuda after a bruising battle. He was the first to attempt seriously to implement a consumption tax to cope with the growing deficits. Moreover, as a former bu­

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reaucrat within the MoF and supporter of Hayato Ikeda, Ohira was one of theirs, guaranteeing at least a sympathetic hearing for their ideas. A member of the class of 1936, he spent 16 years in the Ministry, although as a graduate of Tokyo Commerce University, he was not part of the main­ stream. Among his bureaucratic positions, Ohira served as the secretary to Juichi Tsushima, who twice acted as finance minister. An assignment to the Yokohama Tax Office brought him into contact with Ikeda. The relationship would strengthen and, in 1949, Ohira became Ikeda’s secretary during his tenure as finance minister. He would hold the post along with Kiichi Miyazawa, another future prime minister. As one of a handful of prominent alumni from the MoF who followed Ikeda (a group which also in­ cluded Shigesaburo Maeo), he ran for office three years later. Following election to the Diet, Ohira gradually climbed the party ranks, serving in a number of prominent posts, including finance minister from 1974 to 1976. Ohira’s accession to prime minister in late 1978, therefore, represented a propitious moment for the MoF. Ohira had many reasons to support the intro­ duction of a consumption tax. For one thing, the timing was right. Budget def­ icits peaked in 1979 during his tenure as prime minister, with about 35% of the budget financed from borrowing. Memories of galloping inflation raised con­ cerns that the expenditures would overheat the economy. For another, Ohira had particular responsibility for the financial crisis. While finance minister under Prime Minister Takeo Miki he found himself overseeing a budget that would incur a shortfall of more than ¥3 trillion. Bonds represented the only way to come up with the funds. While some could be paid through construction bonds, Ohira found himself overseeing for the first time since the war the issuance of bonds designed to pay for a deficit from the government’s general account. Ohira, therefore, represented an appropriate figure to lobby for support for the deficit-reducing tax. Within the bureaucracy, a number of officials had a hand in the reform effort. Almost all of them would go on to the top rungs of the MoF, a sign of bureau­ cratic reward. As a result of efforts to introduce the consumption tax, at least two bureaucrats would receive promotions from tax-related positions to admin­ istrative vice minister, a relatively rare occurrence. Initial responsibility in the MoF fell to the administrative vice minister, Masataka Okura. He had been promoted to vice minister from the head of the Tax Bureau and, therefore, had considerable experience with tax issues. With a rep­ utation for resisting political pressure, Okura went on to a strong post-retirement career, serving as head of the People’s Finance Corporation, the Export-Import Bank, and the Bank of Yokohama. Hajime Takahashi, as the director general of the Tax Bureau, had primary responsibility for the tax. Like Okura, he would eventually rise to vice minister. Much of the task .would require political interaction, a task primarily left to the deputy director general or shingikan assigned to the efforts. That role fell to

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Yukihiro Fukuda, another future head of the Tax Bureau and, eventually, a member of the upper house in the Diet. The real mastermind behind the effort, however, was Masaru Mizuno, a name within the MoF that would become synonymous with introduction of the con­ sumption tax. An expert on tax matters, Mizuno spent almost his entire career in the Tax Bureau. A member of the class of 1955, he had begun studying the possibility of a consumption tax in 1976 when he headed the Second Tax Sec­ tion, which dealt with indirect taxes. Mizuno’s efforts would break any number of bureaucratic norms. Rapid ro­ tation would have been counterproductive, resulting in a loss of expertise and continuity. During Mizuno’s reign, therefore, career officials assisting in the effort often held positions for extended periods of time, even where principles of seniority dictated that they be promoted. In connection with the efforts to shepherd the tax through the political maze, Mizuno would serve as head of the Tax Bureau for three and one-half years, an extraordinarily long period by MoF standards. No director general of the Tax Bureau since the 1950s had served a comparable term.1 He also had help. Mamoru Ozaki, class of 1958, would become the shingikan in the bureau for an unusual four-year period (1984—88). He would eventually head the bureau and rise to the post of administrative vice minister. The efforts to pass the consumption tax also saw another bureaucratic first. By the 1980s, the practice of sending high-flying career officials to the Budget Bureau and Secretariat had become entrenched. Mizuno, however, wanted these talented bureaucrats to help in his efforts to obtain passage of the consumption tax. He got what he wanted. In what was labeled the “ tax shift,” many of the best and brightest career officials suddenly found themselves in the Tax Bureau. These included Mamoru Ozaki, who would succeed Mizuno as director general and become vice minis­ ter;2 Tadashi Ogawa, who would later become vice minister;3 Masami Ishizaka,4 a future director general of the Treasury Bureau and the vice minister of the Environmental Agency; and Atsushi Nagano,5 who would eventually head the Securities Bureau. Most of those reassigned to the project had spent their careers in the Budget Bureau and had strong political connections. With the exception of Ozaki,6 all three would serve as aides to Takeshita while he was finance minister, with Ogawa doing so again after Takeshita became prime minister.7 A powerful figure in the Tanaka faction, Takeshita would be a crucial figure in the battle to obtain passage of the tax. With the staff in place, the Ministry also benefited from a particularly well disposed finance minister. Ohira had appointed Ippei Kaneko, a former MoF official from the class of 1937. Kaneko had tax experience, having ended his career as head of the Osaka Tax Bureau. Another follower of Ikeda, Kaneko ran for the Diet in 1960 as a member of that faction. Both the finance and prime ministers were former MoF bureaucrats. Within

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the Ministry, officials had been shifted to maximize political contacts, particu­ larly with the powerful Tanaka faction. The dominoes seemed in place for en­ suring acceptance of the tax by the LDP. The Ohira government formally announced its intention to seek adoption in 1979.8 Matters still required careful management. Initial steps involved successful handling of the Tax Advisory Council, the council attached to the Tax Bureau, which dutifully issued a report calling for a general consumption tax to eliminate the budget deficit. Much of the bureaucratic effort, however, took place in ne­ gotiations with the Tax System Research Commission, the LDP committee re­ sponsible for tax policy. Ultimately, the committee agreed to approve the tax, a step that seemed to ensure passage given the LDP’s majority in the Diet. In what would be a recurring pattern, however, public reaction to the tax was overwhelmingly negative. Opposition parties turned elections held that October into a referendum on the consumption tax. The election would be the first of several in which the consumption tax would play a major role. Indeed, Ohira intended to take his case to the electorate, believing that voters would ultimately see the need for, and support, introduction of the tax. In what would be another recurring pattern, however, the strategy was overtaken by events. A series of scandals involving public corporations surfaced. The inoppor­ tunely timed events made it seem that the LDP wanted to raise taxes before getting the government’s finances in order. Opposition to the consumption tax, therefore, mounted steadily. Reading the electoral writing on the wall, Ohira withdrew his support for the tax shortly before the election. Ohira and the LDP still did poorly in the election. That ended Ohira’s will­ ingness to fight for a consumption tax. His attention turned to more immediate concerns, including efforts by his arch-rival Fukuda to have him replaced as party president. Ohira remained prime minister, but only after narrowly beating Fukuda. Just before upper house elections, Fukuda’s faction absented itself from the Diet, causing a vote of no confidence to pass. In the subsequent campaign, Ohira died, resulting in voter sympathy and a sweep for the LDP. Despite his large majority, Zenko Suzuki, Ohira’s successor, disclaimed any desire to raise taxes. Suzuki had little experience with or interest in issues of finance. He was one of only a small number of prime ministers who had not served as finance minister before heading the government. Suzuki proposed to lead through “ politics of harmony,” something that by definition excluded the contentious issue of the consumption tax. Yasuhiro Nakasone Yasuhiro Nakasone succeeded Suzuki as prime minister. Like Suzuki, Na­ kasone had not served as finance minister and had relatively weak connections within the MoF. In fact, while a former bureaucrat, Nakasone had come out of the Ministry of Home Affairs, the MoF’s bureaucratic arch-rival. He did not seem to be a particularly receptive target for bureaucratic efforts to obtain pas­

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sage of the tax. Indeed, Nakasone came to appreciate the need for a consumption tax only after his overwhelming election victory in 1986 and only after he was searching for ploys designed to obtain a longer term in office. Nakasone became prime minister in 1982 with the backing of the still pow­ erful Tanaka faction. During his five years as prime minister, he had to weather two Diet elections. The first took place in 1983 just after Tanaka’s conviction on bribery charges arising out of the Lockheed scandal. As a result, the LDP did not do well, although the Tanaka faction itself gained seats. Elections in 1986, however, were a sweeping victory for the LDP, and even­ tually earned Nakasone an extended term as prime minister. He won in part on a platform of “ fiscal reconstruction without tax increase,” a stand that seemed to preclude introduction of a consumption tax. Despite the clear victory, Na­ kasone’s continued tenure as prime minister was by no means guaranteed. Elec­ tions for party president were scheduled for November, with Nakasone seeking an extraordinary third term. A member of a smaller faction in a party full of pretenders wanting to become prime minister, Nakasone’s reelection was not inevitable. Nakasone, therefore, had a particular need to shore up support, in part by promoting projects and expenditures sought by members of other factions. The goal, however, conflicted with the MoF’s approach of fiscal austerity. Budgets had been cut; increases would be hard to negotiate. Nakasone had succeeded in raising the level of defense spending and therefore knew how difficult it could be to prevail upon the tight-fisted bureaucracy. With political and economic goals in conflict, Nakasone latched onto the consumption tax as a solution, now renamed a sales tax. The tax would raise additional revenues. Some of the funds could be reallocated to projects favored by key Diet members, shoring up Nakasone’s support and ensuring reelection. Nakasone, therefore, decided to support the tax. The timing also seemed propitious from the perspective of bureaucrats within the MoF. The LDP had just won a sweeping victory. Bureaucrats could use their contacts with the power brokers in the LDP to obtain approval of the tax. More­ over, politicians could postpone voter retribution by avoiding another election for the foreseeable future. Nakasone, however, began the effort with a number of weaknesses. Foremost, he had made a pledge during the election campaign not to raise taxes. For another, the introduction, while couched as a restructuring of the tax system, effectively amounted to a tax increase, at least over the long term, something opposed by large segments of the public and a number of politicians within the LDP. Finally, more interested in raising taxes than in working through the details of the scheme, the plan favored by Nakasone was vague and full of inconsis­ tencies. Result-oriented, the MoF once again mobilized to support the consumption tax. Within the Ministry, Mizuno still represented the key figure in the battle to obtain passage of the tax. He had been promoted to the head of the Tax Bureau

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in 1985. Following the 1986 elections, he embarked on a program to meet with political and business leaders to lobby for introduction of the tax. In addition, Mamoru Ozaki had become shingikan or deputy director general. Both would remain in their respective positions until the tax had finally become law in 1989.g Moreover, promotions made in the summer of 1986 again placed a number of heavy hitters from Budget in the Tax Bureau. In addition, key tax people assumed other important posts outside the bureau. The head of the coordination division in the Tax Bureau, Eisuke Hamamoto, was sent to the critical position of chief of the Documentation Section in the Secretariat. The post had primary responsibility for coordinating matters with the Diet. Hamamoto was another future director general of the Tax Bureau. Once again, the MoF also benefited from a supportive finance minister. Nakasone appointed Kiichi Miyazawa to the post. A former bureaucrat, Miyazawa had joined the MoF in 1942 and remained for ten years. A Todai graduate, he served as the private secretary to the finance minister, Ikeda. Shortly afterward, he left the Ministry and entered politics. Miyazawa held a number of important positions, including minister of MITI, Foreign Affairs and, critically, Finance. He knew the Ministry well and was viewed somewhat warily by bureaucrats within the MoF. As finance minister, Miyazawa immediately signaled his seriousness about obtaining passage of the consumption tax. He selected Sohei Hidaka as his aid. Hidaka had been the chief of the Second Tax Section, the subdivision respon­ sible for indirect taxes, including the sales tax. Hidaka would eventually rise to head the Securities Bureau and the National Tax Agency Administration. MoF officials had to devise a tax plan acceptable to Nakasone. Ensuring enactment, however, fell to the politicians. With Ohira’s example a reminder, Nakasone tried to outmaneuver his opponents. Responsibility for tax issues within the LDP fell to the Tax System Research Commission, a committee within the Policy Research Council. The Commission commonly debated tax issues and called career officials from the Tax Bureau to testify and explain policies. With approval an absolute precondition, Nakasone could not afford to leave matters to chance. The head of the Tax Commission within the LDP ordinarily would have been someone in the Miyazawa faction. Nakasone, however, viewed the likely appointee as too congenial to ensure passage. He therefore broke with precedent and appointed one of his own followers and supporter of the sales tax, Sadanori Yamanaka, to run the committee. Yamanaka had good relations with the MoF. In the 1950s, he had been the parliamentary vice minister for the MoF during Sato’s term as finance minister. While this was ordinarily a weak and powerless position, Yamanaka had used it to create relationships with Ministry officials. He also used the position to become versed in tax issues, an expertise he continued to maintain throughout his political career.. Still concerned about the power of interest groups and opposition within the

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LDP, Nakasone wanted to sidestep the usual political avenues. He therefore turned to the Tax Advisory Council, the council attached to the Tax Bureau, as an initial step in ensuring approval. Unlike other Ministry councils, the Tax Council had become moribund. The LDP Tax Commission had supplanted the council as the principal source for tax policy. Nakasone, however, resurrected the council in an effort to increase pressure on party members, but only after he had inserted some additional members favorable to his views, ensuring that he would obtain his desired outcome. The council worked closely with officials from the Tax Bureau, particularly Mizuno. Predictably, the council came back with a recommendation that the government institute a consumption tax, issuing a report in October 1986. The approach succeeded. The council gave Yamanaka leverage to induce acceptance within the LDP. The following month, the Tax Commission of the LDP, under the guidance of Yamanaka, issued a report (after heated negotia­ tions) favoring the tax. The efforts resulted in support for the tax. At the same time, however, by reducing the role of the LDP’s Tax System Research Commission, Nakasone did not create adequate opportunity for politicians and important interest groups to provide input. Objections, therefore, quickly surfaced. In a highly unusual display of public opposition, some LDP officials openly opposed the proposal, with Kunio Hatoyama, who represented an urban district, an example. As a result, when the tax was introduced, opposition appeared immediately. Nakasone submitted a bill to the Diet calling for the adoption of a sales tax in February 1987. In part, the effort smacked of hubris. He underestimated the breadth of his own popularity. Having promised no new taxes, Nakasone ap­ parently thought that his efforts to raise revenues by privatizing public corpo­ rations would provide the necessary credibility. He was wrong. Traditional constituencies such as shopkeepers and small man­ ufacturers opposed the plan. While many were to be exempt from the tax, they would have had to maintain records to prove their eligibility. Shopkeepers in Japan had little interest in allowing tax authorities a more accurate glimpse of their business, enabling officials to better estimate real income. Nakasone tried to address the concern by promising that tax authorities would refrain from any investigations for three years. To avoid breaking his promise not to introduce a large-scale tax, he created numerous but not well-thought-out exceptions to the tax. His proposal provided for more than 50 categories of exemptions and then claimed that the tax was only “ medium scale.” The antagonism to the tax within the electorate quickly became clear. A byelection in March demonstrated the unpopularity of the tax when a Socialist candidate won a seat in the upper house for the first time in 19 years in Iwate prefecture. The LDP also did poorly in local elections, losing the governorships in Hokkaido and Fukuoka. The opposition in the Diet also mobilized. When the lower-house budget committee approved the tax, opposition party members staged a “ cow walk”

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designed to bring Diet business to a halt. Efforts to pass the budget foundered. Bowing to the inevitable, Nakasone, like his predecessor Ohira, withdrew the tax proposal. Not long afterwards, he stepped down as prime minister. Nakasone failed in large part because of opposition within his own party. He did not engage in enough consensus-building in advance. He also bungled the approach with the public, never fully explaining why the tax was necessary. Moreover, the existence of his “ no new tax” pledge tainted his proposal from the very beginning. The MoF, however, had also made mistakes. Viewing its goal as convincing top LDP politicians, the Tax Bureau felt little need to take its case to the public. Bureaucrats disdained contact with the press. Nakasone’s defeat illustrated the importance of the public’s reaction, something bureaucrats would need to take into account the next time around. Noboru Takeshita The LDP ultimately passed the tax but not until late 1988 and only in return for a reduction in the income tax and concessions to key LDP constituencies. Changes occurred at the bureaucratic level, improving effectiveness. Mostly, however, success came because of more astute management by politicians. The tax was pushed through by an MoF favorite, Noboru Takeshita, a master of compromise. A consummate politician, Takeshita had been in the Diet since 1958 and had held a number of important political posts, including finance minister and secretary general of the LDP. A member of the Tanaka faction, Takeshita had long-standing connections within the bureaucracy and knew how to forge a consensus, even concerning something as controversial as the intro­ duction of a consumption tax. Within the bureaucracy, the faces were largely the same. Once again, Mizuno was head of the Tax Bureau; Ozaki, his number two. Particularly at the assis­ tance of Takeshita, Mizuno would remain in the position until the consumption tax had been introduced and passed by the Diet. In these efforts, however, much of the credit for a more successful bureaucratic approach would go to Tadashi Ogawa, who would become administrative vice minister as a result. Relations between the MoF and Takeshita were particularly close. Takeshita was the heir to the Tanaka faction, a group within the LDP that had particular success working with the MoF. Takeshita also had served as finance minister, providing an opportunity to build up supporters in the bureaucracy. While in that post, he had appointed as aides a number of career officials from the Tax Bureau, including Ogawa, Ishizaka and Nagano. Takeshita essentially staked his career on passage of the tax. In doing so, he also did not repeat some of Nakasone’s mistakes. Not only did he avoid a “ no new taxes” pledge but he listed tax reform as a primary issue on his agenda. He held public meetings to discuss the tax throughout Japan, and engaged in a round of negotiations with key interest groups, winning support from those who had helped torpedo prior efforts. He involved Diet members representing im­

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portant constituencies in the development of the plan. Finally, Takeshita mini­ mized political conflict by obtaining the support of Komeito, an opposition party. A famed consensus builder, he removed the most objectionable provisions. Among other things, small businesses could collect the tax and keep it, rather than pay the amount to the government. Takeshita also increased the size of the income tax cut that would accompany introduction of the consumption tax and rejected the MoF’s proposal for a 5% increase in favor of a more modest 3%. At the same time, part of the success resulted from a significant shift in attitude at the bureaucratic level. In prior attempts to gain acceptance of the consumption tax, officials in the Tax Bureau had been closed and secretive. They had viewed their job as convincing politicians, not the public. No career official received the task of orchestrating a publicity campaign. Press interviews were disdained. This time, however, the same mistakes would not be repeated. The public would be educated. Moreover, the task for overseeing the task fell to Ogawa, a bureaucrat particularly close to Takeshita. Under his tutelage, Tax Bureau offi­ cials would not only give interviews, but would invite them. Bureaucrats fanned out and gave lectures on the need for the tax. Ministry officials were told to convince 500 people each about the merits of the consumption tax. The collective efforts of bureaucrats and politicians worked. The Diet adopted the 3% consumption tax in December 1988, with the tax becoming effective three months later. Getting the tax passed required hard work, commitment and luck. The MoF benefited from the continued dominance of the LDP, something that would not last much longer. It also benefited from the high rate of growth that it had helped engender. A tax increase during a period when incomes were rising and the economy flush seemed far less controversial. These factors would, however, desert the MoF in the next go around with the consumption tax. Despite having done a better job at obtaining passage of the tax, Takeshita paid a heavy price. His popularity was damaged and this made him less able to stay in office once the Recruit scandal broke. Moreover, in upper house elections following adoption of the tax, the LDP lost its majority for the first time since 1955. Mamoru Ozaki’s efforts were rewarded with his elevation to administrative vice minister. Even more remarkable, he received the promotion while serving as head of the National Tax Administration Agency. Within the Ministry, how­ ever, credit for passage went largely to Tadashi Ogawa. It was his efforts that had created an improved climate for passage. His reward would come later. At a time when the Saito family dominated the top positions of the MoF, Ogawa would rise to become jikan, despite his lack of membership in the family, a sign of bureaucratic satisfaction with his efforts. INCREASES In 1990, the remarkable occurred. After a protracted struggle of more than a decade, the Japanese government’s budget balanced. For the first time since the

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1970s, no new deficit bonds to cover shortfalls in the general account had to be issued. Adoption of the consumption tax contributed mightily to the efforts, providing the additional revenue needed to bring the budget into balance. In many respects, however, the MoF benefited from good timing. During the high growth periods of the 1980s, the imposition of austerity measures and tax increases was less noticeable. With the economy accelerating, corporate profits and individual income went up, causing tax revenues to climb. Nor, with the economy booming, was there pressure to use the budget as an expansionary device. All of that changed with the collapse of the economy in 1990. Pressure began to build almost immediately for tax cuts and increases in public spending. Tax revenues also fell as corporate profits went into a tailspin. Maintaining a bal­ anced budget quickly became impossible. With the extent of the slowdown in growth at least initially unclear and the memories of the 1970s still too vivid, the Ministry took a predictably hard-line stance toward proposals designed to throw the budget further out of alignment. It was bad enough that falling revenues would make balancing difficult or im­ possible; tax cuts and increases in spending would only exacerbate matters. The fiscally conservative approach did not emanate only from the MoF but was also consistent with a general Japanese attitude toward thriftiness. As the economic travails continued, however, it became clear that the country was in for an extended slowdown. Political pressure began to build for a government response. Tax cuts and increased spending were the order of the day. The change in the economy coincided with upheavals in the political dynam­ ics. The LDP fell from power for the first time since its creation. Prime Minister Miyazawa was forced to call elections when Ichiro Ozawa and his faction walked out of the party, depriving it of a majority in the Diet. Ozawa turned his faction into a new party, Shinseito or the Japan Renewal Party. Perhaps even more surprising, the elections did not result in the LDP returning to power. Instead, a ragtag collection of parties, united only in their opposition to the LDP, cobbled together a majority. Ultimately organized into a single party, Shinshinto (New Frontier Party), it seemed to be moving Japan toward a two-party system. Morihiro Hosokawa became the first head of state not from the LDP (or its predecessors) since 1947. Hosokawa wanted to loosen the reigns of bureaucratic control. As a governor of a prefecture, he constantly told of the difficulties in having to deal with the overly centralized, slow-to-move bureaucracy. He also had in his government parties that were particularly hostile to the bureaucracy. With permanent mi­ nority status, the Japan Socialist Party had never received much attention from the powerful MoF. Real power in the coalition, however, rested with Ozawa and his faction. He had strong and influential relations with the bureaucracy. Ozawa had served as secretary general of the LDP, a critical post involved directly in budget nego­ tiations with the MoF. Ozawa’s party had also formed from the rump of the

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Tanaka faction, which had traditionally maintained strong relations with the bureaucracy. Although Ozawa had been very outspoken about changes in bureaucratic au­ thority, he was less interested in hostile relations than effective political control. With his influence over Hosokawa growing, a change in attitude toward the bureaucracy by the coalition government became palpable. Cooperation replaced conflict. Ozawa wanted expansionary policies designed to spend the country out of the economic slowdown. To get them meant working with, rather than against, the Ministry. The key figure within the MoF would be Jiro Saito, the administrative vice minister. A rare personality, Saito did not fit the mold of many of his prede­ cessors. Past vice ministers could often be described as coordinators rather than leaders. They avoided conflict and preferred consensus. Saito, in contrast, was direct and had definite ideas. With an overseas stint in Germany, he moved forward with determination. Saito also had a reputation for networking within the Ministry, with a strong “ family” having built up around his leadership. Some were attracted by his forthright attitude; others sought to emulate his more austere approach toward his duties. Saito tended to shun settai (entertaining) and other practices that seemed irrelevant to achieving his pro­ fessional goals. Whatever the reasons, Saito had a strong network within the MoF. Moreover, he used his positions in the Ministry to benefit his followers. Other vice ministers had also done so, but not to the same degree. So complete was his mastery within the MoF that the elevation of Ogawa as vice minister was a notable event because he was not a member of the Saito family. Saito’s approach, however, also created enemies. He irritated the press by showing little patience with off-the-record questioning. He irritated politicians by having too high a public profile and seeming to dictate policy objectives. He irritated those within the MoF who were not part of his family and saw their careers stalled. Saito’s approach was also tinged with a certain degree of imperiousness. Within the Ministry, criticism surfaced not over his decision to negotiate with Ozawa about the consumption tax, a risky bureaucratic strategy, but over his failure to consult sufficiently with the Tax Bureau. Saito largely ignored his own experts. Increased consultation may have generated a tax proposal that would have resulted in greater political and public acceptance. Mostly, however, Saito misjudged the new political realities. At the time, Ozawa and his faction looked as if they would succeed in overthrowing the old political order. A man of strong views and ideas, Ozawa wanted to usher in a new era for Japan. Within the new order, the bureaucracy would become more political and more accountable.10 Nonetheless, an organization as strong as the MoF stood to play a central role, a return to the glory years. It was Saito’s decision, therefore, to throw his lot in with Ozawa and have the MoF support Shinshinto rather than the LDP.

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The tightening connection between the MoF and Shinshinto was clearest in regard to Saito’s efforts to induce the coalition government to accept an increase in the consumption tax. The MoF had reason to believe that the coalition gov­ ernment would favor an increase in the tax. Hosokawa and his party had sup­ ported the idea even before the elections that brought them to power but had not disclosed their position for fear of the electoral consequences. Similarly, Ozawa had called for an increase from 3% to 10%, but only if coupled with large cuts in the income tax. Hirohisa Fujii, Hosokawa’s choice for finance minister, was a member of Shinseito, and someone who could work with the MoF. Fujii had spent 21 years in the Ministry, climbing to the post of budget examiner before leaving in 1976 to run for the Diet. Early statements by Fujii reflected the long-held views of the Ministry. He indicated that “ the cabinet will never issue deficit-covering national bonds” and that it was “ wrong to push for tax cuts as a shot in the arm.” As the slowdown worsened and political pressure built for cuts in income taxes to stimulate the economy, Saito’s approach became clearer. Tax cuts would be permitted in return for a future increase in the consumption tax. He marshaled the usual support, with the MoF-controlled Tax Advisory Council issuing a report in November 1993 calling for an increase in the consumption tax and cuts in top tax rates. The process now required careful negotiations with the ruling coalition to reach an agreement. Along with Saito, Tadashi Ogawa again represented a key figure in the effort. Following the successful introduction of the consumption tax, Ogawa had moved to the Secretariat to head the Documentation Section, an important and intensely political post. Later, from the post of shingikan in the Tax Bureau, he would interact with the LDP Tax System Research Com­ mission, further allowing him to develop political contacts. Negotiations were conducted primarily with Ozawa. The approach, however, ignored the changed circumstances. In this case, other parties in the coalition were entitled to a say in the development. While Ozawa may have been the kingmaker in the coalition, he was not even a member of the largest party, a title that fell to the Socialists. Nonetheless, the negotiations over tax cuts and the consumption tax took place in the traditional fashion, without consulting the other main parties in the coalition. To some extent the explanation was bureaucratic. Saito had developed an exceptionally close relationship with Ozawa. To some extent it was political. Ozawa had embarked on a program designed to isolate the Socialists. He was not about to allow them into sensitive negotiations over tax cuts and Saito had little choice but to follow Ozawa’s lead. Ultimately, the negotiations culminated in an agreement. Income taxes would be cut immediately. The government, in turn, would agree to an increase in the consumption tax, from 3% to 7%, although implementation would be delayed, presumably until after the slowdown had ended. The increase could be expected

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to and did engender some public hostility. But, as in the past, internal dissension proved to be the government’s own worst enemy. Hosokawa’s actions seemed precipitous and dictated by the bureaucracy. In announcing the agreement at a press conference, he labeled the increase a ‘‘na­ tional welfare tax.” When questioned about what he meant or why the increase was to 7%, he had no acceptable answers. With a future increase the price of an immediate cut in income taxes, Hosokawa apparently had little interest in the details. For someone who had come to office ostensibly to limit bureaucratic authority, he now seemed to be doing the MoF’s bidding. The agreement, however, was short-lived. Hosokawa informed his coalition partners shortly before his public announcement. At his press conference, he conceded that the Socialists were not in complete agreement with his plans. Ultimately, both the Socialists and Sakigake strenuously objected to the increase. Opposition was motivated less by policy differences and more by anger over exclusion from the negotiation process. This could be seen by the rapid change of heart of both parties. When they returned to power with the LDP, both quickly agreed to support an increase in the consumption tax. With internal opposition aroused, the tax proposal had to be scrapped. The debacle permanently weakened Hosokawa, with the government falling shortly afterwards. As if to demonstrate his convictions, however, one of his last acts before resigning was to again encourage approval of the increase. The efforts caused considerable trouble for the MoF. Having become too close to Shinshinto, the Ministry would incur the wrath of the LDP once the party returned to power. Both Hashimoto, the future prime minister, and Yohei Kono, then the party president, complained about the relationship between Saito and Ozawa and the reduced contact between bureaucrats and LDP officials. Most of the anger would fall on Saito and his “ family.” Once the LDP returned to power, Saito would be forced into early retirement and shunted off to an unimportant amakudari position. LDP politicians would dictate certain promotions, as Sakakibara illustrated, and drag their feet in consenting to the approval of others, as Yoji Wakui discovered in his effort to become adminis­ trative vice minister. The change in government, therefore, was in some senses a bureaucratic dis­ aster for the already embattled MoF. From a policy perspective, however, it proved to be fortuitous. Whatever the complaints about the MoF’s methods, the need for Japan to get its financial house in order was becoming increasingly apparent. Moreover, despite a Socialist prime minister, the LDP controlled the policies of the new government. Tomiichi Murayama, the new prime minister, therefore found himself having to do a 180-degree turn. He announced plans for an increase in the consumption tax, the very issue that had contributed mightily to his decision to leave the prior coalition. The proposal contained a few face-saving gestures but essentially was little different from the one put forth by Hosokawa.

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LESSONS The adoption of and increase in the consumption tax contained a number of lessons. First, it showed that politicians could engage in affirmative leadership roles, even when difficult and immensely unpopular with the electorate. It dem­ onstrated that the standard adage about politicians reigning and bureaucrats rul­ ing was simply not true. The consumption tax would not have become a reality but for substantial political support and input into its terms. Political rather than bureaucratic sensitivities made the tax a reality. Second, the efforts showed the limits of bureaucratic authority. The tax had become a bureaucratic imperative. Nonetheless, in the absence of sufficient po­ litical will, the effort went nowhere. Some prime ministers declined to accept the electoral consequences and support the change. Others did, but could not gain the approval of the constituencies in their own party. Without strong po­ litical support, the MoF was not capable of gaining acceptance of the tax. Third, the process illustrated the capacity of the bureaucracy to bend its seem­ ingly rigid rules of bureaucratic behavior when circumstances dictated. Efforts to obtain passage of the tax wreaked havoc on the entire system of rotation and personnel changes. Officials stayed in office for extended periods, well beyond normal terms. Principles of seniority were violated, with senior members not promoted with their class in order to maintain their expertise in a particular position. The monopoly of the Secretariat and Budget Bureau over the most talented bureaucrats was broken with the “ tax shift.” In fact, a seemingly in­ flexible bureaucracy could show surprising flexibility when circumstances dic­ tated. Finally, the consumption tax issue illustrated the symbiotic nature of the two realms. The MoF was the first to realize the need for shifts in tax policies. Bureaucrats provided the technical expertise and devised the precise language for the proposals. The reforms became reality, however, only when politicians were convinced, in their own right, that they would either benefit or that it was necessary for the country’s finances. Bureaucratic expertise and political lead­ ership succeeded in a substantive shift in Japan’s tax base.

PART IV

Reform

CHAPTER 15

The Inevitability of A dm inistrative Reform

IS IT BROKEN? The prevailing view is to praise the performance of the Ministry of Finance during the first 30 years following the occupation but then heap criticism on everything that came afterwards. In the area of the budget, conventional wisdom is that the MoF has taken an often stodgy, narrow-minded approach. With re­ spect to the financial markets, the common view is that the MoF has mishandled oversight and harmed the competitive position of Tokyo as an international banking center. Only with a vanquished M qF can these problems be corrected. The herd-like view concerning the MoF’s sins, however, overlooks a number of things. The Ministry’s accomplishments have been significant and not limited to the country’s catch-up period. Both in casting off the antiquated compart­ mentalized financial system and in shifting the tax base, the MoF has created the dynamics necessary to ensure future growth and to solve some of Japan’s inevitable problems, particularly those arising out of the rapidly aging popula­ tion. With respect to the budget, the MoF succeeded in imposing a degree of dis­ cipline on other ministries, without excessively controlling how they spent their allocated funds. It was the MoF that achieved the almost unheralded but re­ markable success of balancing the budget after almost two decades of deficits. Indeed, in many respects, Prime Minister Hashimoto’s announcement of an impending “ big bang” for Japan hardly deserved the attention it received. With many of the ideas for the event coming out of the bureaucracy, the big bang arguably represented an effort by the MoF to accelerate trends already under way. By having the prime minister announce his support for the program, bu­

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reaucrats have successfully minimized some of the inevitable opposition that would arise within the LDP. Not a static organization, the MoF’s approach to financial regulation evolved considerably during the decade of the 1990s. Developments suggested a reduced use of secrecy and increased reliance on official reporting requirements. Informal communications declined as bureaucrats insisted on a more arm’s-length, ob­ jective relationship. Consumer-friendly policies have begun to surface, with ab­ surd vestiges of the compartmentalized banking system, like limits on 24 hour-ATM machines, disappearing. The prohibitions on bank failures came to an end. A clone of the Resolution Trust Company had been created. By early 1998, the MoF, for the first time, published believable statistics on the extent of the bad loan problem. Moreover, the figures arose out of the self-assessment by each bank of its own portfolio, something that would have been impossible before 1995 when the director gen­ eral, Nishimura, put in place new, more aggressive procedures for assessing loan quality. The postwar system of secrecy, consensus and personal relations seemed permanently fractured. Japan’s economy, the financial markets, and bureaucratic practices have un­ dergone considerable evolution since the beginning of the 1990s. More reforms are necessary, particularly inside the MoF. Nonetheless, the process will con­ tinue. Changes in the political and economic dynamics in Japan have made the traditional approach to regulation untenable and additional reform inevitable.

IS LEGISLATIVE REFORM NECESSARY? In debating reform of the bureaucratic state in Japan, many of the proposals have focussed on structural changes. The Prime Minister’s office should be strengthened in order to seize some of the authority now handled by the MoF, particularly in connection with the budget. The Ministry should be dismembered, with tax and banking authority stripped away. A rational case can be made, however, that even in the absence of significant legislative reform, bureaucratic practices will continue to evolve and ultimately become consistent with the transformed economy. Two sources will ensure that this occurs. In the new political era, the MoF can no longer support only the traditional constituencies and interest groups of the LDP. In many respects, bureaucrats will become more inclusive as the LDP continues to broaden its base. In addition, the interests of viable opposition parties will also require consideration. As these interests are absorbed by the MoF, more interest groups will participate in the consensus-building process. In economic matters, the MoF will continue to leam to intrude less and leave more to the markets. In large part it will have no choice. An emerging class of commercial banks and perhaps securities firms will increasingly be less depend­ ent upon the MoF. These emerging superbanks will seek less advice and refuse

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to preclear all impending developments. The MoF’s ability to participate in the micro-management of these institutions will decline commensurately. Superbanks and Foreign Influence In the financial markets, the MoF succeeded in casting off the postwar com­ partmentalized system, despite protracted industry opposition. The result will ultimately make Tokyo more competitive. It also, however, carried the seeds of the MoF’s fall from power. Over time, a class of superbanks capable of provid­ ing all forms of financial service will emerge, engaging in activities from lending to underwriting to asset management to insurance. They will be less beholden to the MoF and less willing to preclear developments, a fundamental source of bureaucratic power. Indeed, Japan already has two universal banks, Mitsubishi-Bank of Tokyo and Daiwa. Traditional city banks, both have expanded into securities activities; both engage in asset management. Although still subject to guidance from the Banking Bureau, these financial institutions increasingly have the power to con­ duct a full range of activities. The trend will continue. With the legal barriers separating most financial institutions repealed, only the MoF’s slow, gradual process of managing decompartmentalization has prevented the remaining large banks and securities firms from engaging in a full range of financial activities. They will eventually gain the authority, either through bureaucratic fiat or absorption of ailing financial institutions. Both Mitsubishi and Daiwa benefited from this approach. Universal banks will have a more varied source of earnings and become less dependent upon lending to high-risk sectors. They will be able to raise funds through the sale of shares or bonds and through a collection of deposits in international and domestic markets. Funds provided by the central bank will decline in importance. With added diversification, superbanks will have greater independence from bureaucratic supervision and control. Similarly, the growing presence of foreign firms will have a comparable ef­ fect. Japan has always been a country where acquisitions of domestic companies were easiest during periods of financial difficulty. With Japanese brokers and banks suffering, the opportunity for foreign firms to expand through acquisition have never been better. Merrill Lynch acquired a substantial portion of Yamaichi, threatening to become the first true foreign retail securities firm in Japan. With growing portions of the financial system gravitating to foreign firms, the MoF’s degree of control will fall further. Moreover, Merrill Lynch was perhaps only the most prominent example. Travelers announced an intent to purchase 25% of the shares of Nikko; Citibank indicated plans to significantly increase the number of branches in Japan. In­ creasingly, foreign firms were finding opportunities in the Japanese financial markets and taking advantage of them to increase their presence significantly. As the financial system continues to evolve, the relationship with regulators

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will change. Banks and securities companies will become larger and more di­ verse and less beholden to the MoF. The compulsion to bring matters to the Ministry’s attention will decline. With less opportunity for comment, the MoF’s ability to affect developments before they occur will likewise decline. The result will be a reduction in the use of administrative guidance. Guidance has little to do with the specificity of laws but arises as a natural part of the informal relationship between regulator and regulated. The problems with guid­ ance, in the end, resulted from the implicit requirement that matters had to be precleared before implementation and from the often lengthy delay required for approval, assuming it occurred at all. Preclearance had a number of bureaucratic explanations, including the desire to avoid embarrassment and damage to an official’s career. It also arose, how­ ever, out of the endemic pattern of constant communication that took place in part because bureaucrats had few other avenues available to learn about devel­ opments in the market and because of industry concern with the consequences of failing to inform the MoF. Superbanks in a new, more competitive era will have less fear of retribution from the MoF. Control over branch approvals and yen funding, the most direct sources of bureaucratic leverage, will continue to decline in importance. In an era of deregulated interest rates, banks will have alternative ways to raise funds, whether through the issuance of bonds or the commencement of a lottery to attract deposits. With reduced concern about the MoF’s power of retribution, superbanks and foreign financial institutions will test the regulatory gray areas more often. Rather than ask approval (which might engender bureaucratic opposition), they will cease to preclear developments and simply implement them. The MoF’s ability to comment on and prevent practices will decline. Indeed, the long-term concern for MoF officials is why a financial institution (at least the largest ones) would even maintain the flow of communication and seek their views. Although not a superpbank, Jonan Shinkin showed how this could work in practice. Shinkin banks or credit cooperatives were struggling in the Japanese financial markets. They took deposits from and lent primarily to members. They largely focused their activities on small businesses of less than 300 employees. They were typically limited to a small geographic area with a diminutive branch network. As with other small financial institutions in Japan, some Shinkin banks sought growth as a means of reaching the critical mass necessary to reorganize and climb into the category of commercial banks. With such small branch networks, however, obtaining significant additional growth in deposits was difficult. To overcome these difficulties, Minoru Makabe, the president of Jonan Shinkin, the country’s largest credit union, decided to rely on a novel approach to attract deposits. On November 7, 1994, Jonan Shinkin announced its “ SuperDream,” a lottery for customers making new deposits. Those making deposits had the right to participate in a lottery where they could win varying amounts of money. The result was a deluge of deposits. The financial institution did not,

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apparently, clear the development in advance with the Ministry of Finance. The MoF was unhappy with the lottery. Although acknowledging that the lottery was not illegal, Jiro Saito, then the administrative vice minister, commented that “ the law is not everything.” Moreover, MoF officials examined the scheme and determined that it would be illegal in a number of other countries. Nonetheless, the MoF did not stop the lottery. The Banking Bureau now found itself in an uneviable position. The lottery program had proved highly popular with small depositors. To elliminate it would have further fanned the view that the MoF was too close to industry and not sufficiently willing to protect the interests of ordinary Japanese. The expected, therefore, did not occur. The MoF had to content itself with the formation of a study group to examine the issue, but otherwise left the practice in place. Japan’s financial markets will, therefore, gradually return to the prewar system when the giant zaibatsu banks predominated. The MoF’s influence over these banks was marginal. They did not borrow from the government, so the threat of reduced funding from the central bank meant little. The MoF rarely inspected them. Vestiges of this independence can be seen today in the practice of former zaibatsu banks refusing to accept retired MoF officials. Similarly, the problems associated with amakudari will decline. At some level, the most significant drawback to the practice was probably the insertion of bureaucrats into positions that should have gone to persons with industry experience. After all, retiring MoF officials spent their careers in the bureaucracy and had no private-sector experience. Many of the financial institutions in the most deplorable shape were run by retired MoF bureaucrats. The jusen com­ monly accepted MoF officials. The first bank to fail since the 1920s had an MoF official at the helm. To some degree, the problem has been undergoing a process of self­ correction. The number of MoF officials appointed to substantive positions in the financial sector has declined. Moreover, with the former zaibatsu banks driving most of the current wave of mergers, the resulting entities are proving hostile toward acceptance of the descending officials. Following the Mitsubishi and Bank of Tokyo merger, Toyoo Gyoten, the retired international vice minister and chairman of the BoT, was shunted aside. So was the chairman of Sakura after the merger between Taiyo-Kobe and Mitsui. To the extent that the larger, more powerful financial institutions have con­ tinued to accept the officials, they have generally done so only for positions with impressive-sounding titles but little actual authority. It is likely that in the future only smaller, less connected financial institutions will be willing to place the retiring officials in substantive positions. Political Influence The other source of bureaucratic change will be the fallout from the ongoing shifts in the political climate in Japan. In part they arise out of increased political competition; in part out of the shift to single-member districts.

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For almost the entire postwar period, the LDP did not have to worry about the need to attract new voters. No viable opposition existed. The party instead concentrated on retaining the loyalty of existing constituencies. A large part of the process was repeated at the bureaucratic level, where career officials rather than politicians engaged in the often messy practice of forging the consensus necessary to keep all of these constituencies happy. The consensus-developing process was not all-inclusive but consisted of the interest groups favored by the LDP. To the extent others had a voice in the process, it usually came late, after a consensus had largely been developed. The approach benefited industry and agriculture at the expense of consumers, unions and urban dwellers. Not important enough to the LDP, these groups were not invited to the consensus bargaining table. In the budget area, the rigidity and lack of a qualitative analysis of budget items also had a political explanation. The MoF was reduced to applying broad ceilings on expenditures as a method of controlling total spending. Qualitative analysis of particular items or budgets would have invited political intervention as affected ministries turned to their allies in the Diet. Moreover, as in the financial reform area, budget priorities reflected the interests of LDP constitu­ encies. They were the ones who had access to politicians and could influence spending decisions within particular ministries. The LDP’s fall from power in 1993, however, brought a new attitude. Real competition now existed; opposition parties had a chance to obtain power. While the LDP demonstrated considerable tenacity in clinging to power, it faced an era of coalitions and minority governments. The LDP, therefore, had to reach out and embrace new interest groups. Bureaucrats would have to do likewise. As a corollary, the advent of single-member districts changed political be­ havior. LDP members had to consider all important interest groups in their district, requiring a broadening of their base of support. The LDP, therefore, suddenly found itself needing to compete for votes and to develop ties with new constituencies. Bureaucrats in the MoF will reflect these new political realities. They also, however, have their own reasons for spreading their tentacles to groups sup­ ported by the opposition. To the extent that viable opposition parties emerge, the MoF can be expected to gradually strengthen ties with them and their sup­ porters. If the MoF does not, opposition parties that come to power will exact retribution because their constituencies have been ignored. Alternatively, they will intervene within the MoF to induce shifts in bureaucratic policy. By in­ cluding these interests groups in the consensus-building process, the MoF will develop changes acceptable to a wider cross section of Japanese society and make political acceptance of bureaucratically engineered policies more likely. Change will also arise from the reality that the LDP has lost its monopoly on substantive expertise. Traditionally, bureaucrats from the MoF entered poli­ tics only under the,LDP banner. Other parties now have a number of former MoF bureaucrats among their members. Not only does Ozawa’s LDP splinter

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group contain former MoF bureaucrats, but so does the Democratic Party started by Hatoyama. These people know how to deal with the bureaucracy, who to call to demand information, and how to get results. Disparity in treatment will become harder. All of this suggests that some tasks currently undertaken by the bureaucracy, such as the development of a consensus over reform, will continue. The MoF, therefore, will remain at the center, manipulating, cajoling and ultimately gen­ erating a consensus on reform. Bureaucrats will, however, have little choice but to expand the decision-making process and include constituencies historically excluded. This will affect the reforms that emanate from the bureaucratic proc­ ess. They will likely be based on a much greater cross section of Japanese society and will likely to be more pro-consumer in result.

CHAPTER 16

R etribution an d R eform

Given the reality of LDP influence over bureaucratic behavior, it is easy to see why attacks by politicians on the MoF have always been highly opportunistic and unlikely to result in significant change. Despite the appearance of omnip­ otence, the MoF has generally adhered closely to the goals sought by powerful prime ministers. These politicians did not see the MoF as a hindrance but as an ally capable of carrying out their initiatives. Opposition politicians have been more critical. Evidence suggests that when they actually succeed in taking power, however, effectiveness replaces vindic­ tiveness as a primary motivation. That means working with the bureaucracy rather than adopting a more confrontational approach. After all, the Hosokawa government was the most openly anti-bureaucratic administration in memory but in the end opted for cooperation over conflict. To the extent bureaucratic reform contemplates increased responsiveness to political goals, this ignores the existing close relationship between the two groups. Politicians already have the power to implement policies. The favored treatment of rural financial institutions in the jusen bailout had a political rather than bureaucratic explanation. Moreover, reforms that call for a substantial weakening of the Ministry pose risks for politicians. First, they would impair bureaucratic effectiveness. While weakening the bureaucracy may have some public appeal, ultimately politicians motivated by desires for reelection are more interested in implementing policy initiatives or rewarding their constituencies. For that, an intact MoF works better than a dismembered one. Second, transferring responsibility from the MoF to politicians would not necessarily provide more control but would result in greater responsibility. Un­ der the existing system politicians already can step in any time and rearrange

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spending or reform priorities. Increased responsibility would mean that blame for unpopular spending decisions such as the bailout of the jusen or excessive deficits would fall on politicians rather than bureaucrats. Indeed, beyond public consumption, little evidence indicates that politicians, particularly those in the LDP, truly want to assume the political functions of the bureaucracy. They prefer to leave the arbitration of disputes among key constituencies to the bureaucracy. They do not want to be directly tainted by the efforts to bail out the financial markets. The problem is that reform is necessary. Like the financial system itself, bureaucratic practices need to be transformed. The type of reform currently debated in Japan, however, is not likely to be effective. Breaking up the MoF may constitute a form of punishment that pleases voters, but it will not result in more effective policy-making. A smaller regulator or an MoF stripped of tax oversight will not reduce the level of guidance or end the personal nature of the regulatory relationship. More effective reform should focus on overcoming bu­ reaucratic impediments to change rather than punishment for perceived mistakes. REFORM EFFORTS Most of the efforts at reform of the MoF to date have been matters designed for public consumption rather than improved effectiveness. They have at their core punishment and retribution, not a desire to change fundamentally the bal­ ance of power within the Japanese government. As a result, calls for substantive reform were the tatemae, while the honne was to leave matters largely where they were. Most reform efforts have focused on a dismembered MoF. Calls to break up the MoF have occurred before, although for somewhat different reasons. Throughout the postwar period, occasional proposals arose to strip from the MoF the power over the budget. The most notable efforts were in the 1950s and led by Ichiro Kono, a powerful faction leader in the post-occupation LDP. The efforts waned, however, because politicians learned that they could achieve their objectives without dismantling the MoF. Under Ikeda, first as fi­ nance minister then as prime minister, the Ministry abandoned much of its con­ servative attitude toward spending. Government budgets grew dramatically, consistent with political goals. More recent reform efforts have a fundamentally different purpose. They do not arise out of a desire within the LDP to transfer power from the bureaucracy to politicians. The two groups are not locked in a power struggle. At least for the LDP, the MoF has, during the postwar era, accommodated its principal objectives. Instead, present-day efforts have arisen in large part out of the public’s per­ ception that bureaucrats were responsible for the country’s economic malaise and therefore needed to be punished. The MoF, as the most powerful bureauc­ racy, received the largest share of blame. In addition, the Ministry’s lack of

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humility and its mismanagement of a number of high-profile matters made it a ripe target for reform. In that sense, retribution represented the guiding moti­ vation. The desire for retribution also had a political dimension. Parties without ac­ cess to power were traditionally ignored by the bureaucracy, particularly the MoF. With the LDP monopoly over, they could now enter the government. As a result, they sought to exact revenge. The most vociferous calls for reform in the Hashimoto government have come not from the LDP but from its coalition partners, Sakigake and the Socialists. The motivations matter. Politically inflicted punishment becomes less ap­ pealing as it causes a decline in the bureaucracy’s effectiveness. Thus, while the Hashimoto government publicly indicated support for a vanquished MoF, it was at the same time dependent upon the bureaucracy to achieve a number of policy goals. LDP-inspired reforms, therefore, were enough to appease the public’s need for retribution, but not designed to significantly affect the MoF’s power.

THE LIMITS OF REFORM Reforms cobbled together by the LDP, Socialists and Sakigake called for both a partial dismantling of the MoF and internal reorganization. In the summer of 1998, the Financial Supervisory Agency opened its doors, absorbing the MoF’s task of licensing and examining banks and securities companies. Internally within the MoF, the Banking and Securities Bureaus were combined into a single Financial Planning Bureau. Primarily retributive, the reforms were not designed to make the bureaucratic decision-making process more efficient, rational or transparent. They will not, therefore, have much impact on the MoF’s style of regulation. Nor will an “ independent” inspection agency remain free of MoF influence. Capture will almost certainly occur. If anything, therefore, the reforms, though painful, will ultimately benefit the Ministry.

Independence and Capture The creation of the Financial Supervisory Agency and its placement outside of the MoF will not fundamentally alter bureaucratic behavior. There is no guarantee that an “ independent” agency will be more effective than the MoF in examining financial institutions. First, the Financial Supervisory Agency will have less prestige. During the annual recruitment process, a bureaucracy charged solely with licensing and examinations will not appear on the radar screen of the most talented Todai graduates. Second, the Agency will be susceptible to greater industry or political influ­ ence. Industry capture of a bureaucracy can occur, as the compensation scandals illustrated. Moreover, the bureaucratic response will be less robust. After the

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compensation scandals, the MoF completely changed the leadership of the Se­ curities Bureau, bringing in untainted officials from Budget and Tax. This option will be lost with the creation of an independent regulator. Mostly, though, the independent regulator will not in fact be independent. Bureaucratic domination is inevitable. Japan has had little experience with in­ dependent regulators. Independence in Japan means bureaucracies answerable directly to the prime minister rather than another bureaucracy. Independent agen­ cies, however, have often found themselves in a weak position within the bu­ reaucracy and have had to tie themselves to a stronger ministry for support. Nor have the consequences of bureaucratic capture been particularly auspi­ cious. As a bureaucracy that lacked a strong base of support, the Fair Trade Commission had little power for most of the postwar era. Captured by the MoF, chairmen were often retired bureaucrats, usually former vice ministers. Despite its jurisdiction over the Anti-Monopoly Law, the FTC rarely brought enforce­ ment actions. In general, the agency was viewed as a toothless tiger. It took pressure from the U.S. to step up the policing of anti-competitive behavior to induce some stirring of activity. The Economic Planning Agency (EPA) constituted another example of a bu­ reaucracy captured by the MoF and the inevitable consequences. Capture dam­ aged the agency’s reputation. The perception in Japan is that the EPA publishes growth forecasts more in line with MoF desires than with economic reality. This view was given credibility by the EPA’s issuance of wildly optimistic projec­ tions during most of the economic slowdown in the early 1990s. All of this suggests that any “ independent” bureaucracy created to oversee the financial markets will not, in fact, remain independent. The probability of capture by the MoF remains high. Capture may take time, given the current public hostility toward the MoF. Nonetheless, it will occur. Indeed, the LDP reform measure contemplated, as it must, considerable in­ teraction between the Financial Supervisory Agency and the MoF. Most of the initial employees in the new inspection agency came from the MoF, since it represented the repository of officials with experience in the area. Although not headed by an MoF official, the number two person, Hideichiro Hamanaka, came from the Ministry. Moreover, 373 of the 403 employees were from the MoF. In addition, the refonn called for regular meetings and, strikingly, did not ban personnel exchanges between the two bureaucracies. Moreover, while the MoF may not have had the power to inspect, it retained substantive policy authority and the responsibility for managing crises in the financial markets. Given over­ lapping jurisdictions, consultations are likely to be extensive. Ties between the two bureaucracies will, therefore, be strong. Capture will not occur because of some Machiavellian effort by the MoF, although the Ministry will have plenty of reasons to bring the agency under its wing. Instead, the FSA will likely invite it. As many of the new postwar bu­ reaucracies learned, they needed close connections with a powerful ministry to enhance their power base. An agency overseeing the financial markets still must

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have political and bureaucratic influence to accomplish its task. Obtaining this as an independent bureaucracy will be difficult. With capture inevitable, the MoF ironically stands to benefit from the change. Many of the most embarrassing problems that occurred during the economic slowdown in the 1990s were connected to the inadequacies in the inspection process. The failure to uncover and correct bank problems sooner, the wide­ spread underreporting of nonperforming loans, scandals involving the accep­ tance by examiners of largess from banks, and the inability to detect a $1 billion trading loss by Daiwa Bank in New York, all lent credibility to the contention that the MoF was losing its grip on the financial markets. These responsibilities are now foisted off on a new agency. Moreover, the MoF has retained the right to step in if a real crisis develops. The MoF, therefore, lost the worst and potentially most embarrassing part of financial oversight without any real diminution in substantive power. Internal Reorganization The other half of the LDP’s reform package concerned an internal reorgani­ zation within the MoF. A single bureau became responsible for the financial markets. Both Banking and Securities (and responsibilities for currency futures in the International Finance Bureau) were combined into the Financial Planning Bureau. These efforts also seem misguided and unlikely to bring about any appreciable improvement in the bureaucratic approach to regulation. The proposal to some degree tracks developments in the financial markets. With the end to the separation between banking and securities activities, the two industries will increasingly converge. The Financial Planning Bureau reflects this reality and provides a single office to regulate both industries. The approach also has some potential bureaucratic benefits. Decompartmentalization foundered because of the dispute between the Securities and Banking Bureaus (and their respective industries). Resolving differences will be easier now that both are subject to the same bureau and overseen by the same director general. Nonetheless, the disadvantages more than outweigh the benefits. The new bureau will contain seven divisions, one responsible for banks (the Credit Di­ vision) and another responsible for securities firms (the Market Division). As a result, the highest-ranking person responsible for the industry will no longer be a director general but a far more junior kacho or division director.1 This will reinforce the status quo and risk-averse decision-making process. Some bureaucrats within the MoF have shown greater willingness to take de­ cisive actions in the face of crises. Nishimura, the director general of the Bank­ ing Bureau, demonstrated this in connection with the bailout of the jusen and the implementation of corrective action principles for banks. It was significant, however, that decisiveness occurred at the top, by someone largely on his way out of the bureaucracy.2 Shifting responsibility to lower levels of the bureauc­

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racy, to officials who still have to worry about future advancement, will make this type of decisive behavior less likely. Moreover, the reform conflicts with history. Both Banking and Securities were at one time divisions within other bureaus. It took major financial crises— the panics of 1927 and the stock market collapse in the early 1960s— to create the awareness that a division within a bureau was not enough. Another financial crisis may likewise demonstrate that this new configuration does not work. The reforms also conflict with the trend toward specialized independent reg­ ulators responsible only for securities markets. The securities industry has grown in complexity. The international trend, therefore, has been to opt for a special­ ized securities regulator with expertise in the area.3 Banks have been allowed to enter the securities markets but usually through a separate subsidiary subject to the oversight of the securities regulator. The reforms in Japan, therefore, conflict with the trend. Finally, some of the benefits seem marginal. Separate bureaus for the banking and securities industries did impede financial reform in Japan. With the wall separating the two industries gone, however, the most divisive source of conflict has been eliminated. While some disagreement between the two industries and their respective bureaus continues to exist, the problems would likely be solved in a less protracted fashion, even if the two bureaus remained independent. In the past, some internal reorganization of the MoF did prove useful. Changes made in the aftermath of the compensation scandals in the 1990s, particularly the creation of the Securities and Exchange Surveillance Commis­ sion, were beneficial. Modeled somewhat after the National Tax Agency Ad­ ministration, the SESC had primary responsibility for policing the securities markets. The Surveillance Commission, however, remained under the MoF um­ brella and the staff included a large number of MoF employees. The commission was, therefore, independent of the Banking and Securities Bureaus, but not of the MoF as a whole. The reforms were criticized at the time as paper tigers. Some viewed them as cosmetic efforts to placate the public, with little likelihood of any fundamental shift in behavior. After all, the SESC remained in the MoF and was subject to the full panoply of bureaucratic pressures. The changes, however, were more fundamental and effective than most critics perceived. Until the reforms, the financial bureaus operated as almost independ­ ent fiefdoms. While the Securities Bureau apparently knew about the compen­ sation payments, it had sole responsibility for handling the matter. The failure to clamp down on the payments may have been irresponsible, but was motivated by a desire to support the declining stock market. An independent investigatory unit destroyed this monopoly over information. It created another avenue for exposing improper practices and providing com­ petition for the other bureaus, essentially acting as insurance that the Ministry as a whole would be less predisposed toward industry. The LDP reforms, however, go in exactly the opposite direction. Rather than

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create additional avenues of information flow and bureaucratic competition, they consolidate power into a single bureau. Moreover, they effectively transfer power to lower-level bureaucrats, who will be even less likely to impede their career advancement by taking controversial and decisive stances. CONCLUSION All of this suggests that internal reorganization of the MoF can be effective. The changes, however, should emanate not from a desire to punish, but from a desire to rationalize the bureaucratic decision-making process. The LDP plans were not properly motivated and, therefore, are likely to prove ineffective. Reforms in the summer of 1998 illustrated how the MoF benefited from the reorganization. To address the problem of insolvent banks, the LDP (with the assistance of the MoF) pushed forward a plan to rely on bridge banks. Bridge banks involved the replacement of existing management of a troubled bank with administrators appointed by the government. The administrators would attempt to improve the health of the bank, and then arrange a sale or merger. The plan, however, contained a number of tasks that were likely to antagonize politicians and banks. Closing too many banks would make it appear that the politicians had lost control over the economy and would create potential retri­ bution at the ballot box. At the same time, the threat of replacing existing management would impose strain on the relations between bureaucrats and fi­ nancial institutions. The MoF, however, succeeded in avoiding the unenviable task. Instead, it fell to the newly created Financial Supervisory Agency. It was that entity that would incur the criticism and pressure from politicians, and the hostility of banks. At the same time, the MoF had not necessarily lost its ability to control events. Instead, the Financial Supervisory Agency would no doubt consult with the MoF over both the identity of administrators and the banks to be seized. Thus, the MoF remained influential but succeeded, because of the administrative reforms, in avoiding blame for the unenviable tasks associated with the program. Care, therefore, needs to be taken in altering the bureaucracy. Severely weak­ ening the MoF— by breaking it up, for example— may not produce the expected benefits, while reducing effectiveness. The bureaucracy does need to cast off the remaining vestiges of the postwar system and devise a decision-making process that works better in a more developed, complex environment. Most of these changes must occur at the bureaucratic level and should be designed to accelerate the transition process already under way.

CHAPTER 17

The E ndgam e: T ransform ing th e M inistry of Finance

Much of Asia is in economic upheaval. In many respects, countries like South Korea and Thailand find themselves having to deal with the transformation from a developmental to developed economy. While the process has just begun in these countries, it has been under way in Japan for more than a decade. Japan is poised to become the first rapidly growing Asian economy to entirely cast off its postwar economic system. Particularly in the financial markets, Japan has largely dismantled the postwar system, no small feat given its central role in the country’s economic recovery. Only a few vestiges remain. Yet changes in regulation are not enough. Bureau­ crats responsible for guiding the country’s recovery also have to accept the inevitable consequences of transformation, substantially changing their role in the economic decision-making process. At the beginning of the 1990s, the Ministry of Finance had no intention of significantly reducing its role in the economy. Consensus, secrecy, informal relations and an incremental approach to reform were all controlling principles. Banks would not fail and budgets would balance. The country’s long-running economic slowdown, however, demonstrated the untenable nature of the ap­ proach. As the decade came to an end, signs of change were everywhere. Bu­ reaucrats increasingly opted for a more open and objective approach to regulation. Increased reliance on market forces will help the MoF manage the most im­ mediate problems. As more financial institutions fail, the long-term result will be a healthier financial system. As the budget deficit continues to grow, the likelihood of a more qualitative review of expenditures will increase. The inevitable reduction in authority does not necessarily mean a less prom­ inent role for bureaucrats in the economic decision-making process. Indeed, the

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indications are that the MoF remains at the center of the policy formulation process. In the summer of 1998, the LDP announced a program to create bridge banks, something largely developed within the MoF. Moreover, the unpleasant task of closing troubled banks fell not to the Ministry but to the newly created Financial Supervisory Agency. The MoF also succeeded in keeping its most powerful bureaucrat, Wakui, in office, despite opposition within the LDP and reprimands by the finance minister. To remain influential, however, bureaucrats must update their approach to regulation, increasing their expertise and broadening the groups included in the consensus-developing process. Changes in behavior cannot simply be ordered. Some will occur naturally as the MoF adjusts to a new political order and new economic realities. Others, however, require internal shifts within the Ministry. Essentially the MoF must do what it did to the financial markets: jettison the postwar system and create a more flexible approach to regulation capable of dealing with the complexities of a market economy. Fortunately, the shifts need only be modest. They do not, as some have sug­ gested, require a dismantling of the Ministry or the closing of Todai. Moreover, with inspired leadership, bureaucrats have the power to institute the necessary reforms. A number of things must occur in order to update bureaucratic practices. First, with respect to the financial markets, increased emphasis must be placed on specialization. The MoF should end the sacrosanct separation between practical experience and bureaucratic careers. Particularly in dynamic areas such as the financial markets, officials will need actual exposure to the industry they regu­ late. In addition to altering the system of rotation and providing practical ex­ perience, the pattern of placing officials whose careers were spent in the Budget Bureau at the head of the bureau overseeing the financial markets needs to stop. Second, the information-gathering process must be expanded and changed. The MoF needs to become less reliant on personal contact for information about the financial markets. The approach leads to excessively close relations between regulator and regulated. Whether favoritism or the appearance of favoritism, the effect is the same, particularly when the policies that emerge favor business at the expense of consumers. At the same time, however, the quality of the information flow must improve. The MoF should no longer tolerate improper reporting. No matter how bad the news, reports must be accurate so that the public has confidence in the infor­ mation and can accurately assess the health of financial institutions. Other changes will also be necessary. Impediments to initiative and risk­ taking must be reduced. The bureaucracy also needs to foster greater tolerance of dissent. Finally, in an unusual twist of fate, the MoF needs to find a way to stay relevant in competitive financial markets. Ironically, taking a 180-degree turn and becoming avidly pro-consumer represents the best way to do it.

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SPECIALIZATION Officials remained in the MoF for 30 or more years. Under the system of rapid rotations, they usually held a position for too short a time to master its intricacies. Moreover, after they served in a position and accumulated experience or knowledge about the substantive area they often rotated to an unrelated office, making little use of that expertise. Each successor had to relearn the area, some­ thing more difficult in complex and dynamic areas such as derivatives. Rotation into unrelated posts meant that officials did not make use of the expertise developed in a prior position. Without the necessary expertise, they were particularly dependent on non-career officials for substantive knowledge and on industry for policy initiatives. The MoF viewed itself as training managers rather than technicians or spe­ cialists. The days when the MoF educated generalists and therefore had directors general with very little experience, a particular problem with respect to the financial markets, should end. If anything has become clear in the 1990s, it is that MoF officials have had an inadequate understanding of the mechanics of the markets and have been overly dependent upon entities under their oversight for information. Moreover, regulation of the financial markets requires some unique skills, including strong relations with foreign financial regulators. As financial insti­ tutions become more international, so will the problems. Nishimura, the director general of the Banking Bureau who failed to notify the Federal Reserve Board of Daiwa Bank’s trading losses, came out of the Budget Bureau. So did the first director general of the new Financial Planning Bureau, Kazuhiko Fushiya. Be­ fore the appointment, he had served as director general of the Treasury Bureau and deputy director general of the Budget Bureau, not particularly adept training for a regulator overseeing the financial markets. Those regulating the financial markets, therefore, need specialization. Longer portions of a bureaucratic career should be spent in the insurance/banking/securities/intemational finance areas. Officials can accumulate knowledge and ex­ perience without having to constantly relearn a new area. This will allow bureaucrats to more readily understand, and approve changes in, industry reg­ ulation. Indeed, some of the reforms in the financial sector resulted from this type of expertise. Bureaucrats rotated into international financial organizations and learned about other approaches to regulation. These lessons became useful when bureaucrats confronted crises and needed a nontraditional response. The problem of lack of specialization is not, however, limited to the financial markets. Longer tours of duty and greater specialization could benefit other bureaus. Those responsible for reviewing budgets of other ministries typically stay in the position for two years, hardly enough time to really learn the anom­ alies of another bureaucracy’s budget. In a few celebrated cases, MoF officials

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have remained shusa for extended periods.1 The practice, however, needs to become the norm rather than the exception. Precedent exists for greater specialization. The Tax Bureau is populated by specialists. Directors general spend most of their careers on tax-related matters with only brief sojourns in other bureaus or outside the MoF. Those who reach the top of the Budget Bureau have traditionally spent a disproportionate portion of their careers in that area. The same approach needs to be used with respect to the financial markets. The reform, however, will represent a significant change. It conflicts with the practice of rapid rotations. Rapid rotation has entrenched bureaucratic purposes. It gives officials greater understanding of and sensitivity to the multiple tasks performed by the MoF. Rapid rotation also allows every class to hold the im­ portant mainstream positions necessary to reach the top posts in the MoF. Fi­ nally, rapid rotation allows aspiring bureaucrats responsible for personnel decisions to build support and gain allies. These bureaucratic justifications, however, must give way to more effective regulation. It does not require an elimination of rotation or an end to exchanges of personnel among bureaus. It does suggest that officials must concentrate on particular substantive areas and remain in those bureaus long enough to gain true expertise. MoF officials may still be managers rather than technicians, but they must be managers with substantive expertise. INDUSTRY EXPERIENCE Consistent with greater expertise within the MoF, officials in the financial area also need more education about private-sector practices. It will enhance their understanding of the markets and reduce their dependency on the industry they regulate. With rare exceptions, all MoF officials came directly out of uni­ versity. They had no private-sector experience. The vacuum could be filled in one of two ways. The MoF could hire laterals from banks or securities firms. The Ministry has, in the past, brought in laterals when the need demanded. The liaison office, opened during the occupation, contained a number of laterals. Some came from banks, others from academia. In general, however, the routine hiring of laterals would conflict too much with bureaucratic practices, and disrupt the system of promotions. It might be possible to arrange for a number of fellowships or other short­ term appointments directly from the private sector. They could be assigned to specific divisions within the Banking/Securities/Intemational Finance Bureaus. These positions would provide the MoF with a wealth of information about how things work in practice. The approach will probably not work for a number of reasons. First, bureau­ crats tend to look down on those in industry. While the fellows may have unique

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knowledge, the career officials within the MoF would not likely make the best use of the expertise. Second, those coming out of industry will continue to have strong loyalties to their original employers. MoF officials will know, therefore, that confidential policies stand a strong chance of being leaked to the private sector. The best, least disruptive method of gaining practical experience would be to rotate bureaucrats through the private sector. A few years at a bank, securities firm or insurance company would provide substantially greater understanding about how decisions are made and why. The Bank of Japan already does this. The central bank regularly sends its officials to banks for practical experience. MoF officials could likewise use the training. The training would have to be serious, not the good times that career officials have when they go overseas to get an advanced degree. Moreover, the process would likely require repetition. MoF officials would need to rotate in and out of the private sector at least a few times during their career. To the extent including foreign financial institutions, the practice could involve both industry experience and foreign language training. INFORMAL RELATIONS Through much of the postwar period, the MoF relied on informal commu­ nications as the principal means of uncovering problems in the financial markets. Securities firms and banks would informally report matters before they surfaced publicly. Bureaucrats would often leave to the financial institution the task of investigating the matter and devising a solution. The system involved close personal interaction between officials in the two groups. Discussions in relaxed settings after work became common. Over time, the entertainment evolved into a lavish process and included trips to Hong Kong, golf outings and expensive gifts. Those in the bureaucracy shared information not only about regulatory initiatives but also dates for “ surprise” inspections. In the transformed economy, the practice has gone in to decline. Negative publicity over excessive closeness between bureaucrats and their wards caused the MoF to ban the practice, even before scandals surfaced in early 1998 over the alleged improper entertaining of bank examiners. More critically, however, the approach no longer ensures an informed bureaucracy. With the advent of superbanks and the growing presence of foreign financial institutions, not every event will be reported to the MoF on an informal basis. The financial bureaus will increasingly find themselves “ surprised.” The MoF has also learned that the informal system of disclosure has debili­ tating flaws. The wide underreporting of nonperforming loans demonstrated the often meaningless nature of official reports. Time and time again, seemingly healthy banks would suddenly collapse, with the extent of the problem far greater than what had been disclosed. In some cases, financial institutions deliberately understated their problems.

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In most instances, however, they probably did not know their true extent because of inadequate internal procedures. The trading losses by Daiwa Bank in New York demonstrated that even large financial institutions had serious problems with their own operating procedures. A scandal that occurred over 12 years and involved thousands of trades could have been stopped by a simple separation of trading and settlement functions within the bank. This suggests that the MoF must develop and rely upon a more formal, reg­ ularized method of obtaining information. The process must place greater em­ phasis on the integrity of the formal reporting process. The burden does not rest entirely with the MoF. Financial institutions will need to develop internal pro­ cedures designed to ensure the efficacy of the information provided. Much of the underreporting problem in the 1990s arose because of the inability of finan­ cial institutions to adequately assess their own loan portfolios. Steps have been taken in this direction. The Banking Bureau now requires financial institutions to undertake more frequent inspection of their loan port­ folios and has gradually moved them toward international standards. The bureau’s ability to more accurately disclose problem loans in early 1998 rep­ resented the first obvious fruits of this tougher and more accurate disclosure policy. Substantial improvement in reporting, however, requires more than elevated regulatory requirements. The MoF must also signal to the industry that inac­ curate reporting will no longer be tolerated. A few public displays of anger by the MoF (with appropriate penalties), and the days of Daiwa Bank dragging its feet so that it could avoid disclosure of a billion-dollar trading loss will be over. The result will be better information for the MoF and greater public con­ fidence in the efficacy of the disclosure process and the health of the financial system. A more formal system of communication does not rule out informal contacts but simply reduces reliance on them. At the same time, MoF officials must, to the extent they become aware of problems (such as the trading losses by Daiwa Bank), be more willing to make the matter public rather than leave completion of the investigation and the timing of disclosure to the financial institution. SECRECY Secrecy represented another common aspect of the postwar financial system. A troubling and damaging aspect of bureaucratic behavior, it kept the public in the dark. Public disclosure only occurred after solutions had been devised. Even then the full extent of the problem was often not revealed. Bureaucrats justified secrecy as necessary to maintain confidence in the fi­ nancial system. In earlier days, it contributed to the illusion that the MoF was in complete control and the financial system was the epitome of stability. By the 1990s, however,, the approach had become dysfunctional. The run on Cosmo Credit, the “ sudden” collapse of Yamaichi and the lack of credibility assigned

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to the financial institutions all were a consequence of excessive reliance on secrecy. With matters more complex and the problems more severe, problems no longer occurred at a leisurely pace, allowing the MoF to handle them deliber­ ately, quietly and individually. Moreover, excessive secrecy exacted a growing cost. Inaccurate public disclosure meant that all financial institutions were sus­ pect, with the public unable to discern the good from the bad. For much of the decade, the Banking Bureau refused to admit the obvious, resulting in a general loss of confidence in the entire financial system. Changes, however, have begun to occur. Nishimura, as the head of the Banking Bureau, broke with the past when he made more complete disclosure in connection with the bailout of the jusen. In early 1998, two years after he imposed selfassessment requirements on banks with respect to their loan portfolios, the bu­ reau finally issued something approaching accurate data on the true extent of the financial crisis, tripling prior estimates of the quantity of bad loans. The practice, however, needs to become more routine. Reduced reliance on secrecy is not without risk. In addition to demonstrating that the MoF cannot control all problems, it has important and dramatic policy implications. Publicizing the full extent of a problem means that a solution must be devised immediately. It will eliminate the sometimes leisurely and incre­ mental approach to devising solutions often employed by the MoF. Indeed, once Nishimura released data on the seriousness of the jusen problem, liquidation became inevitable, as did the use of public funds. The ability to engage in forbearance disappeared. A more open approach, therefore, reduces bureaucratic discretion. It also, however, represents a form of defense. The MoF’s decision in early 1998 to disclose the true extent of the bad loan problem coincided with proposals to use public funds to bail out recovering financial institutions. In effect, the MoF wanted to convince the public of the seriousness of the problem and to reduce political opposition. Disclosure facilitated these goals. In the transformed econ­ omy, therefore, a more open approach benefits bureaucrats. LEADERSHIP More than any other “ reform,” the MoF needs leaders capable of transform­ ing the bureauc'racy and casting off the now outmoded vestiges of the postwar regulatory system. The bureaucracy has proved capable of allowing true leaders to rise to the top. Tomomitsu Oba, the international vice minister, amounted to a strategic thinker who brought reform to the financial system. Nishimura, as head of the Banking Bureau, succeeded in solving the jusen problem despite considerable criticism, internal objection, and an abbreviated career. Nonetheless, the MoF does not produce enough examples of those with the necessary leadership qualities. Doing so will require the elevation of decisive­ ness over consensus-building as a required skill for top positions. That will only

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occur, however, with changes to bureaucratic practices and greater vision by those making personnel decisions. As currently configured, the system of promotions entails the designation at a relatively early stage of those in a class destined for the highest ranks of the Ministry. Once anointed (usually in their 30s), they receive a series of important but low-risk, not particularly difficult, posts. The need to handle risk or decide difficult issues is not part of the traditional education of someone on the path to vice minister. Indeed, bureaucrats on an upward path want to avoid involve­ ment in any controversy that might blemish a career. The positions used to determine who becomes vice minister should become a better test of the ability of bureaucrats to deal with crises and difficult issues. It may mean that the mainstream steps to vice minister need to be changed. Alternatively, the tasks assigned to mainstream positions should be toughened. Decisiveness means little without the requisite substantive expertise. Partic­ ularly in the era of the Saito family, top posts within the MoF, including those overseeing the financial markets, have gone to officials who spent their career in the Budget Bureau. This sends a signal about the relative importance of the non-budget-related bureaus. Those spending substantial portions of their career regulating banks or securities firms know that their upward advancement in the MoF often will be limited. Finance-related bureaus are entitled to their quota of the best and brightest and those officials deserve the possibility of advancement to the highest levels of the MoF. That would include more frequent promotion from the financial bureaus to administrative vice minister. The practice of elevating officials who have no substantive expertise to the top of the financial bureaus also hinders effective decision making. They lack significant experience in the industry they supervise, something harder to justify as financial markets grow in complexity. Nishimura, head of the Banking Bureau during the scandal over Daiwa Bank’s $1.1 billion in trading losses, may well have handled the situation differently had his career been spent in banking rather than budgetary affairs. Whatever the position and the background of the elevated official, promotions need to go to those willing to act decisively. Many of the current problems confronted by the MoF have arisen out of an unwillingness to confront contro­ versy. Forbearance, the official policy of the Banking Bureau toward troubled financial institutions, represented an institutionalized philosophy of inaction. Nor was the attitude limited to that particular bureau. The MoF needs to produce directors general and vice ministers who are ca­ pable of ushering in a new era. In the short term, those making promotion decisions (both within the bureaucracy and the “ old boys” ) will need to ag­ gressively search for these qualities. Rumors circulated that Toyoo Gyotan, a retired international vice minister, intervened to advance the promotion of Eisuke Sakakibara, a very nontraditional and decisive candidate. More of this type of behavior will need to occur.

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The willingness of the bureaucrats to alter significantly the criteria for pro­ motions is uncertain. When Komura stepped down in early 1998 as administra­ tive vice minister, the post went to Koji Tanami, the runner-up from the year before. Because Tanami had already left the MoF, he had to be invited to return to the bureaucracy, an unusual step. Rather than use the opportunity provided by a mid-year resignation to promote a nontraditional candidate, the bureaucracy relied on the usual standards in determining the promotion. RISK-TAKING Perhaps the most difficult reform will be the inculcation of an attitude that encourages bureaucrats to accept greater risk in making decisions. An inherent problem in all bureaucracies, the dynamics of bureaucratic behavior in other countries often create some incentive to take risks. Successful risk-taking may result in promotions. More importantly, bureaucrats often do not see government service as a lifelong endeavor. Risks may attract the attention of outside em­ ployers, even if unsuccessful. Moreover, if the risk fails and their career effec­ tively ends, they can leave the bureaucracy and obtain a new position, untainted by the prior experience. Ministry officials confront different dynamics. Their entire careers will be spent in the bureaucracy. Risks that fail may permanently damage a bureaucratic career. In particular, unsuccessful risk-taking can draw unwanted attention and blame to an official, permanently damaging a bureaucrat’s prospects for ad­ vancement. Destined to remain in the MoF for life, officials could still face another 10 or 15 years effectively consigned to unimportant positions. Moreover, the task of finding positions outside the Ministry for retiring officials falls to the bureaucracy itself. Those in disgrace would likely receive a substandard post­ retirement career. Encouraging risk-taking and decisiveness has no easy solution. With an end to rapid rotations and increased expertise, bureaucrats will develop greater con­ fidence in making decisions. In addition, bureaucrats aware that they will be in a position four or five years (rather than the current one or two) know they cannot as easily play for time and rotate out before a problem surfaces. The result will be more decisiveness if not actual risk-taking behavior. In addition, however, those who take risks require bureaucratic rewards. An occasional extraordinary promotion to a risk-taking bureaucrat, particularly someone willing to grapple with controversy, and not otherwise in the main­ stream, would send a message. Those otherwise outside of the mainstream would now know that a new path to the top of the MoF existed, but only if they were willing to take additional risks. Perhaps the most intriguing recent example of this concerned the promotion of Eisuke Sakakibara to vice minister for international affairs. Sakakibara’s ca­ reer was not mainstream and, by conventional standards, he had no chance of

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obtaining a top post in the MoF. He did not graduate from the law faculty at Todai (his degree was in economics), was older (having begun a graduate de­ gree), and performed poorly on the administrative exam (the second-worst score of all those who passed). His decision to leave the Ministry in mid-career to teach was likely motivated by the perception that his bureaucratic future held little promise. When he returned, he was in a novel position. Given the lack of upward mobility, he had nothing to lose by taking risks. Under the approach “ one position, one accomplishment,” Sakakibara took a number of relatively unim­ portant posts and managed to distinguish himself at each one. He also main­ tained close contact with politicians, visiting them often. As a result, he was promoted first to director general of the International Finance Bureau and then to international vice minister, the number two person in the Ministry. Sakakibara demonstrated that those taking risks can overcome bureaucratic limitations and reach the highest levels of the MoF. He also showed that taking risks can attract attention and overcome the lack of mainstream support. In that sense, Sakakibara demonstrated that success could be achieved through deci­ siveness and he represented a possible alternative model for younger bureaucrats trying to advance within the MoF. Sakakibara also demonstrated that a resultoriented philosophy and a willingness to use political and foreign contacts could reinvigorate the public impression of the MoF. While perhaps too early to tell, Sakakibara unfortunately does not seem to represent a trend within the MoF toward rewarding decisiveness. Indeed, his result-oriented nature and willingness to take risks earned him the enmity of many mainstream officials within the MoF. His high rank was not attributed to his bureaucratic effectiveness, but to his political contacts. To the extent true, the MoF still has not produced a high-ranking candidate that received promo­ tions entirely because of risk-taking behavior and decisiveness. APOSTASY Commentators have often noted that the MoF has in place a bureaucracy­ wide religion on budgetary matters, usually associated with a fiscally conser­ vative approach and balanced budgets. In the financial area, the MoF also had a religion. It was the need for stability, which was most clearly manifested in the convoy system, widespread reliance on secrecy, and the belief that inter­ vention by regulators could solve any financial crisis. A consistent regulatory philosophy has advantages. The MoF often acted with a single- minded determination, something necessary to affect change. Only with this bureaucratic religion would the Ministry have had the ability, over 15 years, to bring the budget into balance. At the same time, however, these positions became so imbedded in the bu­ reaucratic psyche that the MoF adhered to them long after they lost their ef­ fectiveness. In doing so, the MoF often found itself woefully unprepared when

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the policy had to be changed. Rigid acceptance of the ban on bank failures meant that the MoF had few concrete plans for handling the collapses when they inevitably occurred. Rigid opposition to deficit financing meant that when deficits appeared, the MoF had little ability to limit their sale. The attitudes were endemic; dissent was not viewed with favor. Bureaucrats unhappy with the approach to regulation had little ability to induce change. The usual solution was simply to make clear the lack of compatibility and request positions in other bureaus. Dissenters, therefore, left without attempting to change the often suffocating consensus within a bureau. The MoF needs to develop greater tolerance for dissent. Those disagreeing with the reigning consensus will at least force proponents to continue to defend the position, something harder to do as its relevancy recedes. Moreover, dissent may at least raise concerns and cause effective alterations. In some cases, as dissent builds, counterproductive policies will be abandoned sooner, before they result in embarrassing crises. The best way to signal approval of dissent and apostasy would be to promote officials who have a reputation for outspokenness and independence. Bureau­ crats would begin to learn that these positions could actually enhance rather than end a career. It would provide a new path to the top rungs of the MoF, something that would appear attractive to at least some Ministry officials. HIRING PRACTICES The MoF needs to create a broader bureaucratic perspective in formulating policy. Doing so must start at the beginning, with greater diversity in hiring. The lack of diversity in hiring practices contributes to the single-mindedness of the MoF. Excessive reliance on Todai graduates, particularly those from the law faculty, ensures that MoF officials have almost exactly the same academic ex­ periences. Unsurprisingly, therefore, the tendency has been to approach prob­ lems in the same fashion. Some progress had been made in reducing reliance on the law faculty at Todai to supply career officials. The MoF regularly takes a few people from other schools and from other faculties within the University of Tokyo, particularly economics and the math/sciences. In the class of 1998, only eleven of the 17 members were from Todai, the smallest number since 1973. Still more, however, needs to be done. The primary responsibility for hiring falls to the head of the personnel office (hisho kacho) within the Secretariat. Examples of more aggressive and diverse hiring patterns have occasionally surfaced. During the occupation, Takeshi Watanabe focused on universities other than Tokyo and Kyoto, accepting career candidates from Keio and Waseda. In the 1960s, Fumio Takagi demonstrated a more liberal view, particularly with the hiring of officials like Sakakibara, de­ spite his coming from the economics faculty and having started a Master’s pro­ gram. Nonetheless, these efforts at diversity have been isolated and sporadic.

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The other, more subtle problem with reliance on Todai, however, is the in­ adequate representation of women within the career bureaucracy. An entering class at the MoF is almost entirely male. The class of 1997 contained only one woman; the class of 1998 only two, the most women since 1965. In some respects, the dearth of women arises from the emphasis on Todai. The University of Tokyo has a relatively small percentage of women. As long as this is the main source of career officials, the MoF will have few women. Mostly, however, it flows from a deep-seated belief within the bureaucracy that women cannot handle the long hours and rigors of the position, particularly if they also seek to raise a family. The failure to accept women has policy implications. Officials in the MoF traditionally claim that they represent the views of the middle class in consensus formulation, eliminating the need for participation by consumer interest groups. To the extent that bureaucrats purport to speak for the middle class, they cannot do so with only half the population represented within their ranks. It would be an interesting experiment to see how many MoF career officials knew the price of a kilo of rice or the transaction fee imposed by banks on bill payments. In addition to the policy implications, expanding the number of women would increase the pool of talented, qualified individuals for entry into the MoF. For women seeking a career in the bureaucracy, various ministries already have a reputation for greater openness toward, and acceptance of, women. The Minis­ tries of Agriculture, Construction, Transportation, and Trade are part of this group. The MoF is not. Attracting more women will require cultural changes within the Ministry. Bureaucratic practices are largely incompatible with raising families. Ministry officials work long hours, sometimes all night, and spend only short intervals with their families. With more women in the Ministry, officials would have to become more efficient with their days. The result would almost certainly be a substantial reduction in the amount of informal entertaining and personal con­ tact. In some respects, a kinder and gentler MoF with more women may prove beneficial in other ways. As the MoF declines in overall importance in the economy, attracting the best and brightest will become more difficult. Already, certain ministries, such as Home Affairs, compete with the MoF for the best graduates. A more balanced environment, including the hiring of a larger number of women, will attract additional candidates (male and female) and help retain the same high-quality applicant pool.

BUDGET REFORM The approach to financial regulation by the responsible bureaus has evolved considerably in the 1990s. Moreover, it has done so in a messy and glaringly public process. The Budget Bureau, by comparison, has not undergone a com-

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parable evolution. Despite its central role in the budget formulation process, the bureau has become almost hidebound. The bureau has gradually and inexorably ceded away most budgetary au­ thority, particularly through the refusal to engage in qualitative analysis of ex­ penditures. Other ministries receive what amounts to a relatively fixed percentage of the total budget, with the specifics largely left to their secretariats. The approach has facilitated macroeconomic goals, including the imposition of ceilings on overall expenditures. From a microeconomic perspective, how­ ever, the result has been an inefficient pattern of spending. At a time when society’s needs have changed and huge deficits have become the norm, this approach can no longer continue. Several things must occur. The one-year cycle for reviewing budgets should be abandoned. Instead, ministry budgets should involve a multi-year approach. In that way, budget examiners could use the time to examine all aspects of the agency’s expenses, rather than just new items. The tenure for shusa should be lengthened. Deputy budget examiners typically have responsibility for a particular budget for two years and then rotate to a new post. With a longer term, career officials would gain greater expertise over budget issues for a particular ministry. Some deputy budget examiners do serve for four years, but do not spend the entire period on a single ministry’s budget. They therefore lack the requisite continuity needed to know the intricacies of a particular ministry’s spending pattern. At the same time, however, the case can be made that the career staff devoted to budget analysis should be increased. It may well be the case that with greater flexibility and multiple-year budget analysis, the bureau could handle the task without additional personnel. Nonetheless, it does suggest that incessant reduc­ tions in the number of Ministry officials may cause counterproductive conse­ quences. Greater qualitative analysis will increase inter-ministry conflict and, initially, generate political opposition. Nonetheless, with the reforms inevitable, the Budget Bureau can either lead the process or sit on the sidelines and let others do it. Moreover, qualitative analysis of expenditures will free funds that can be spent in a manner consistent with the wishes of those in the Diet, something that will ultimately prove popular. STAYING IN THE GAME For most of the postwar era, the MoF had a clear mission. In the financial markets, bureaucrats made certain that the compartmentalized system worked effectively, funneling funds to industries promoting recovery. In the budget area, they imposed order by minimizing deficits, leaving Japan’s excess savings to industry. Both missions have largely been fulfilled. For the MoF to continue to have a central role in the economic decision-making process, a new purpose

l“

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Financial Markets. With respect to financial regulation, the MoF will likely confront an identity crisis, similar to the one already under way at MITI. The early precepts associated with micromanagement of the financial markets no longer exist. Funds do not need to be directed to particular industries; banks do not need to be sheltered from competition. With the end of the compartmental­ ized financial system, the Faustian bargain between industry and the MoF has collapsed. No longer will financial institutions receive guaranteed profits as a price for intrusive bureaucratic behavior. Moreover, as the evolutionary process continues, the MoF may find itself reduced almost entirely to a regulator of small banks. A category of superbanks is emerging. They will have little reason to consult with, or listen to, the guid­ ance of inexperienced bureaucrats in the Ministry. The evolution represents a return to the past when a handful of zaibatsu banks controlled most financial assets and the MoF had far less influence in the financial markets. To the extent regulators intend to remain an important, influential participant in the financial markets, a new raison d ’etre must be developed. The financial bureaus must devise new forms of bureaucratic leverage over the largest finan­ cial institutions. Only if the Ministry provides a strong reason for these banks to communicate and preclear developments will they continue to do so. To remain relevant, therefore, the MoF must embark on a new path. The most effective would be to become the outspoken guardian of consumer interests. Unlike U.S. banks, Japanese banks are not subject to a multitude of laws designed to protect consumers and local communities. Japan has no Equal Credit Opportunity Act or Community Reinvestment Act. In fact, Japanese banks have often had trouble adjusting to these requirements when operating in the United States. Adopting a strong pro-consumer strategy would allow the MoF to make up some of these deficiencies. To some degree this would entail an aggressive effort by the MoF to reduce the obvious impediments to more pro-consumer banking. Restrictions on operating hours, the use of ATM machines, lotteries and product innovation could be eliminated. In addition, however, as fair credit and com­ munity reinvestment legislation in the United States illustrates, financial insti­ tutions can be subjected to more affirmative obligations to meet the credit needs of their communities. The approach would also give the Ministry the continued right to intervene in the affairs of the largest financial institutions. Banks and securities firms would know that if they engaged in behavior that appeared contrary to the interests of consumers, they would draw bureaucratic ire. As a result, they would continue to preclear practices that could disadvantage consumers. Moreover, by taking such a position, the MoF would also resume its customary role as pro­ tector of the national interest. Finally, the approach will help win back public support for and approval of the MoF. It will be politically popular, reducing the likelihood of intervention.

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Mostly, however, the approach will help maintain the MoF’s central role in the financial markets. Budget. In the budget area, the MoF was the postwar guarantor of fiscal resolve. Budgets balanced. For almost 25 years, the MoF ensured that govern­ ment deficits did not burden private credit markets, leaving the scarce funds available for industry. All of this has changed. With Japan now having a surplus of credit, the government resigned to large deficits for the indefinite future, and the budget increasingly made up of nondiscretionary expenses, the MoF’s post­ war purpose in the budget area has come to an end. Given the trends, the Ministry is gradually being reduced to a scribe, simply imposing uniform ceilings with no broader goal or purpose. Japan’s budget, more than anything else, needs greater qualitative analysis. Expenses can be reallocated to a more efficient use, avoiding the need to raise revenues through tax increases. The approach goes against bureaucratic instinct. Attempting to impose qual­ itative standards will cause conflict. Nonetheless, the longer bureaucrats delay, the more irrelevant they will become to the budget process. The MoF, therefore, needs to play a more proactive role in the process. By taking the initiative and identifying inefficient expenditures, the Budget Bureau can free up funds for other uses and avoid the need to raise taxes, an always unpopular alternative. Moreover, as the financial experts, bureaucrats in the MoF will know better than politicians where to find the fat in the budget. The shift in approach will reinvigorate the Budget Bureau’s role. The ap­ proach will require constant contact with politicians. Other ministries will have reason to fear Budget Bureau oversight. This time, however, the primary goal will be rational spending patterns for a transformed economy.

CONCLUSION Japan has shown that open markets are not the only means of achieving growth. Through most of the postwar era, the country had a command economy, more like the Soviet Union than the United States. Politicians deliberately left in the hands of the bureaucracy much of the responsibility for the maintenance and oversight of the system. In a developed economy, that style of economic management has become counterproductive. As Japan completes the casting-off of the postwar system, the country again has an opportunity to show that the prevailing approach used in most other industrial countries does not represent the only and inevitable model. Room still exists for a country that leaves consensus formation and the details of policy execution to the bureaucracy. Conflicts need not all become matters of partisan political debate. Developments in Japan suggest that the emergence of this model is under way. Nonetheless, it will not occur inevitably. An economic system operating

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in more competitive international markets cannot operate with an approach to regulation still mired in the postwar system. Japan is on the cusp. The future may or may not contain a powerful MoF. Resolution depends upon the bureaucracy itself and whether it can implement the internal changes necessary to remain a positive force in Japan’s economic development.

N otes

CHAPTER 1 1. The most influential books in this area are Chalmers Johnson, M1T1 and the Jap­ anese Miracle, and Karl van Wolferen, The Enigma o f Japanese Power.

CHAPTER 2 1. During the occupation, Allied forces commandeered the MoF building to use for office space. Bureaucrats were given three days to vacate the building. Takeshi Watanabe, then in the Secretariat, assigned the task to a junior bureaucrat, Ryogo Hashimoto (class of 1934), the father of future Prime Minister Ryutaro Hashimoto. He completed the task on schedule. 2. The prime minister also appoints parliamentary vice ministers. The position, how­ ever, has little authority and represents a training ground for politicians seeking to de­ velop influence with a particular ministry. 3. In the postwar era, no administrative vice minister has served longer than a twoyear term. Moreover, while the practice in the 1950s and 1960s was for two-year terms, thereafter most served for only one year. The resignation of the administrative vice minister in early 1998, midway through his first year, marked the shortest tenure since the 1940s. 4. Before the war, the mainstream also included the correct high school. The most prestigious was Dai Ichi Kotogakko (Ikko), the First Higher School. Ikko was absorbed by the University of Tokyo after the war. 5. According to Takeshi Watanabe, the position was scheduled to go to Shigesaburo Maeo, a graduate of the law faculty at the University of Tokyo. Maeo, however, got into a disagreement with Allied officials and, pursuant to their orders, was transferred to a lesser position as head of the Mint. Shortly afterwards, he quit the MoF and entered politics.

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6. They included Masamikichi Funayama, who served as Vice Minister from 1951— 1952; Tadashi Ishida (1959-1961); Satoshi Sumita (1969-1971) and Sadaaki Hirasawa (1989-1990). 7. The two were Mamoru Ozaki (1992-1993) and Tadashi Ogawa (January 19961997). 8. Koji Tanami, who headed the Treasury Bureau before going to the Office of the Cabinet Councilor, became vice minister in January 1998. His promotion was unusual in that he had already left the MoF, the first time that had occurred in the post-occupation era. Ordinarily, the post would have gone to the head of the Budget Bureau but that did not occur because of some uncertainty about his ultimate promotion. 9. The International Finance Bureau was originally called the Foreign Exchange Bu­ reau. The name change occurred in June 1964. 10. They are listed in note 6 in this chapter. Twice, directors general of the Interna­ tional Finance Bureau were promoted to vice minister, but only after they headed another bureau. They were Masataka Okura (head of the International Finance Bureau from 1974-1975 and head of the Tax Bureau immediately before promotion to vice minister) and Tadashi Ishida (director general of the Foreign Exchange Bureau from 1955-1957 and head of the Banking Bureau immediately before promotion to vice minister). Simi­ larly, at least twice, a vice minister headed the Securities Bureau. Tadashi Ogawa (vice minister from January 1996-1997) served in the position from 1992-1993 before heading the Tax Bureau and the National Tax Agency Administration. Jiro Yoshikuni (vice min­ ister from 1972-1973) served in the post in 1967 before heading the Tax Bureau. 11. An exception occurred during the war. The MoF created its own liaison office, primarily to avoid having to rely on the office largely staffed by bureaucrats from the Ministry of Foreign Affairs. With few fluent English speakers, the MoF went outside the Ministry to staff the office. Some officials were taken from academia (Gengo Suzuki) and some from the private sector. Those from the private sector left the Ministry once the occupation ended. 12. One of the two women graduated from Keio University, a school that rarely pro­ duced MoF career officials. Interestingly, Keio was the alma mater of then Prime Minister Hashimoto. 13. In the Budget, Treasury and International Finance Bureaus the title of deputy director general is jicho. 14. Toshiro Muto, the head of the Secretariat, also offered to resign. He did so not because of any direct implication in the scandal but because the bank inspection unit was in the Secretariat. Hashimoto, then acting as Finance Minister, declined to accept the resignation.

CHAPTER 3 1. From 1982-1986, Takehiro Sagami, the former Vice Minister for International Af­ fairs, worked for Sumitomo Bank, something considered a great coup at the time. The experiment did not work out, however, and was not repeated. 2. They did sometimes take positions in securities companies, in part because these firms had a reputation for paying higher salaries than banks. That career officials did so rarely, however, apparently resulting from the low status of the industry and the recog­ nition that any amakudari position would require technical expertise.

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3. Following the compensation scandals in the early 1990s, the MoF tried to capture the top position at the JSDA, much the way it had captured the comparable position at the Tokyo Stock Exchange in the 1960s. Industry opposition, however, doomed the effort. 4. As Yusuke Kashiwagi recounted, when he moved from the MoF to become deputy president at the Bank of Tokyo, he was given the following advice: “ Bureaucrats are safe if they don’t make a mistake, but in running an enterprise errors are often unavoid­ able. And in the end you must produce results that more than offset the errors.” This required him to do away with “ deeply entrenched habits,” which he described as “ easier said then done.” See My Hometown, 139. 5. In the mid-1990s, the MoF informally prohibited retiring bureaucrats responsible for financial regulation from accepting posts in private banks or securities firms. The ban was eventually extended to all career staff at the MoF. 6. Samuel E. Neel and Raymond Vernon, “ Japan Has A Bank Problem,” Banking, October 1946, 45, 118-119.

CHAPTER 4 1. Reprinted in Memorandum for Chief, Economic and Scientific Section, from Walter K. LeCount, Chief, Finance Division, ESS, October 6, 1948. SCAP Records, Suitland, Maryland. Loans were to be made only if “ in the interests of Japanese economic recov­ ery” and “ only after all other sources have been found unable to supply the funds.” 2. From 1946 through 1949, the RFB provided 23.8% of all bank loans. General Survey o f the Japanese Economy, Ministry of Finance, June 1, 1954, 33. 3. Supreme Commander for the Allied Powers, Historical Monographs, 1945-51, His­ tory o f Non Military Activities o f the Occupation o f Japan, volume XIII, Part C, Mon­ ograph No. 39, Money and Banking, 18-19. 4. Money and Banking, Monograph No. 39, 38 (“ The RFB became the target of widespread and intense criticism throughout 1948 and early 1949. It was accused of making loans on the basis of bribery or the borrowers’ political influence.” ). 5. Memorandum for Chief, Economic and Scientific Section, from Walter K. LeCount, Chief, Finance Division, ESS, October 6, 1948. SCAP Records, Suitland, Maryland. 6. Memorandum to Major General Marquat, from Joseph M. Dodge, re: Industrial Financing, December 3, 1950. SCAP Records, Suitland, Maryland (“ If I am correctly informed, I believe the change of [the Industrial Bank of Japan’s] functions from indus­ trial financing banking was at least partially initiated by this headquarters. That places us in a somewhat embarrassing position of having to reverse a previous action, if this is to be done.” ). 7. Reform proposals that did surface created controversy within Japan. Mostly, though, the efforts failed because of the lack of interest in Washington. Officials there expressed concern about attempts to impose on Japan a system that resembled the U.S., without “ adequate consideration of many fundamental differences which existed between the two countries and with little regard to Japanese customs and psychology.” Memorandum to Major General W. F. Marquat, Chief of the Economic and Scientific Section of SCAP, from Paul M. Atkins, Expert to the Secretary of the Army, October 25, 1948. SCAP Records, Suitland, Maryland.

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CHAPTER 5 1. A prewar government-controlled “ special bank,” the Yokohama Specie Bank was slated for liquidation because of its perceived role in the war. Overseas branches “ op­ erated under the direct control of the local military administration” and had “ become the principal instrument in the Government’s complicated system of currency manipu­ lation in occupied countries.” Monograph 39, above, 4. The Banking Bureau vigorously resisted these efforts by occupation officials. The compromise was to liquidate the YSB but transfer the assets to the newly created Bank of Tokyo. For a more in-depth discus­ sion of this event, see Brown, Japanese Banking Reform and the Occupation Legacy: Decompartmentalization, Deregulation, and Decentralization, 21 Denver J. of Int’l Law and Policy 361, 378-380 (1993).

CHAPTER 6 1. Money and Banking, Monograph 39, above. 2. See Memorandum to Banking & Foreign Exchange Division, ESS, GHQ, SCAP, from Y. Fukuchi, Chief, Liaison Department, the Bank of Japan, July 14, 1950, National Archive, Suitland, Maryland. 3. See Chapter 2, note 9. 4. Shokei Arai, a member of the LDP and former bureaucrat from the MoF, admitted that he had earned profits on an account with Nikko that he had placed in a friend’s name. According to published reports, Arai earned ¥40 million in one year in a discre­ tionary trading account on an investment of ¥120 million, with most of the funds in the account coming from an uncollateralized loan. Arai committed suicide before the matter was definitively resolved. 5. There seems to be general agreement within the securities industry that the infor­ mation came directly from the National Tax Administration Agency. At least some, however, think that the information was leaked by non-career officials to affect promo­ tions within the MoF. The timing supports this, with the information becoming public at the time MoF officials engaged in their annual rotation. Under this theory, the MoF took advantage of but did not deliberately cause the opportunity provided by the com­ pensation scandals. Moreover, rather than the MoF spontaneously seizing the opportunity, some indicated that steps were taken only after the finance minister, Hashimoto, insisted on them. 6. The first official bureaucratic response to the practice was the disallowance of tax deductions taken on the compensation payments. Nikko, for example, had its taxes ad­ justed by ¥1.46 billion for the period from October 1987 through March 1990.

CHAPTER 7 1. The number of commercial banks proliferated, at one point climbing to almost 2,000. Most of the banks were small, with almost half having capital of less than ¥100,000. The number began a gradual decline after the turn of the century when minimal capital requirements _were imposed. Still, bank failures and mergers were common, with 956 banks disappearing between 1905 and 1936.

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2. For a discussion of the government banks and what happened to them after the war, see Brown, Japanese Banking Reform and the Occupation Legacy: Decompartmentalization, Deregulation, and Decentralization, 21 Denver J. of Int’l Law and Policy 361, 378-380 (1993). 3. Annual Report of the Bank of Japan, Federal Reserve Bulletin, May, 1928, 331. 4. The explanation was bureaucratic. The Banking Bureau continued to discourage consolidation by requiring merged banks to close overlapping branches. Nor did there seem to be much will within the bureau to encourage significant reordering within the financial sector. In addition, legal restrictions prevented mergers among different cate­ gories of banks. Nishi-Nippon Sogo, the largest sogo, merged with Takachiho Sogo, a troubled financial institution. The conversion was a reward for taking on the additional liabilities. 5. Sumitomo’s efforts to merge with Kansai Sogo Bank in 1978 showed how difficult it could be to induce a small but relatively healthy bank to merge. The president of the smaller financial institution was a retired Sumitomo official. The zaibatsu bank owned a majority of the sogo’s shares. Moreover, behind the scenes, the Banking Bureau sup­ ported the effort. The merger, however, never happened. Mid-level officials at Kansai Sogo knew that their upward advancement would be greatly reduced once the two banks combined. Clients of the sogo were also not happy about the likely increase in credit standards that would follow the merger. Despite the high level of control, Sumitomo could not proceed in the face of such opposition. 6. The Banking Bureau also saw to it that the bank received an additional but in­ valuable benefit. Nishi-Nippon was allowed to join the Association of Regional Banks, a decision announced by the chairman of the association, Jiro Yoshikuni, a former vice minister of the MoF. It effectively amounted to recognition that the bank had not only converted to a commercial bank, but had become a regional bank, something with sub­ stantial status. 7. The Cosmo problem could not be placed exclusively at the door of the Banking Bureau. The credit union was under the regulatory oversight of the Tokyo government, a result of a 1951 law giving local governments control over these small financial insti­ tutions. The failure to take quicker steps resulted in part from a deterioration in the relations between the MoF and the Tokyo city government. 8. Assets of Hyogo were transferred to a new bank, with the losses absorbed by the Deposit Insurance Corporation and commercial banks. This would be the last time moral suasion would succeed in convincing commercial banks to pay the costs of a bailout. 9. The decision to force banks to meet MoF/Bank of Japan standards ran into bu­ reaucratic constraints. Originally, the Banking Bureau intended to disclose to commercial banks the standards used by examiners in conducting their inspection. Examiners, how­ ever, considered the information proprietary and resisted disclosure. Only after concerted pressure and legislative mandates did officials in the bureau succeed in having the in­ formation disclosed to commercial banks. 10. The Securities Bureau has begun to allow new entrants into the securities industry. From the summer of 1997 through January 1998, the bureau issued six licenses to new securities firms.

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CH APTER 8 1. See generally Allocution o f the Daiwa Bank, Ltd., February 27, 1996, 1-2. 2. The meeting apparently consisted of Tsuda, Iguchi, Hiroyuki Yamaji, a managing director, and Fumio Kitora, an executive of Daiwa Trust. See Tsuda Allocution, 1. 3. Iguchi Allocution, 3 (Daiwa had to, among other things, falsify internal books and records in connection with cover-up efforts). 4. Plea hearing for Daiwa Bank, February 28, 1996, p. 27. 5. E-mail message to author dated September 1997. 6. Allocution of Masahiro Tsuda, March 29, 1996, p. 3. 7. Testimony of Neil Levin, Superintendent of Banks, New York State Department of Banking, before the Senate Banking Committee, November 27, 1995. 8. See Nikko Securities Co. International, Exchange Act Release No. 32331 (Admin. Proc. May 19, 1993). Nikko disclosed the loss in increments, over a period of months, thereby avoiding any revelation of a single, large loss.

CHAPTER 9 1. The regional agricultural cooperatives actually fell under the joint supervision of the MoF and the Economic Affairs Bureau in the Ministry of Agriculture. As a practical matter, however, oversight and inspection were handled by the Agricultural Ministry. The local agricultural cooperatives were the responsibility of the prefectural governments. 2. A good account of the political involvement in the reform effort appears in Frances McCall Rosenbluth’s Financial Politics in Contemporary Japan.

CHAPTER 10 1. For a discussion of efforts to successfully negotiate a ¥1 trillion budget in the 1950s, see Kashiwaga, My Hometown. 2. Officials from the MoF traditionally monopolize the two top positions in the agency, the director generalship and the secretary generalship. 3. MoF officials traditionally control the post of director general of the Personnel Department. 4. The Second Compensation Division in the Bureau of Compensation, which deter­ mines salaries, is typically headed by an MoF official.

CHAPTER 11 1. The Financial System Research Council, for example, included retired officials from the MoF and the Bank of Japan. In addition, however, the Ministry of Agriculture had a representative because of its oversight of the regional agricultural cooperatives.

CHAPTER 12 I. Ryogo Hashimoto resigned from the MoF in 1947 and entered politics two years later.

Notes

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2. Tadayuki Koizumi, class of 1953, married the daughter of Ichiro Kono; Takeshi Noda, the daughter of Takeo Noda. 3. In the days of LDP domination, the party president was invariably the prime min­ ister. With the advent of coalition governments, however, that is no longer inevitable. When Murayama was prime minister in the LDP-led coalition government, Yohei Kato served as party president of the LDP. 4. Financial regulation is handled by the Financial Issues Research Council (Kinyu Mondai Chosa-kai). In addition, however, the MoF also interacts extensively with the LDP’s Fiscal Policy Council (Zaisei Bukai), primarily on budgetary matters. The two organizations often meet together. 5. At the time, the position was held by Takanori Sakai, a retired bureaucrat from the MoF. He was head of the Zaisei Bukai from November 1996 until September 1997. 6. There is even a coordination zoku (chosei zoku), which has the task of handling disputes among zoku. 7. For an interesting discussion of how this works in practice, see the discussion by Isamu Murakami, the construction minister in the second Kishi cabinet, reprinted in Masumi Junnosuke, Politics in Japan, 252-53 (1995). In his negotiations with the min­ ister of finance, he refused to give in on certain budget demands. He did so knowing that when the negotiations occurred at the final stages among the top three officers of the LDP, he would get his request since two of them were from his faction. His strategy worked as expected.

CHAPTER 13 1. One Bank of Japan official indicated the belief that it was Morinaga, someone very close to Ohira, who recommended Maekawa, with Ohira simply following Morinaga’s recommendation. Either way, Ohira was able to bypass a close ally of Fukuda’s. More­ over, Morinaga succeeded in both guaranteeing that the post would eventually go to Sumita (by exacting a commitment from Maekawa that he would support Sumita), ful­ filling his responsibility to support MoF candidates, and forcing Sumita to accept a position subservient to Maekawa, a form of bureaucratic punishment for his close ties to Fukuda and antagonism toward the Ikeda/Ohira faction. 2. “ Japan: Worst Finance Minister—Takemura’s Troubles,” Euromoney, September 30, 1995. 3. In fairness, most of Sakigake’s losses were due to defections rather than electoral defeats. 4. This would not be the last time Hashimoto would have trouble filling the post of Minister of Finance. When Mitsuzuka resigned as Finance Minister in early 1998, Hash­ imoto offered the position to another member of that faction, Yoshiro Mori. He was reportedly asked three times to take the position but refused because of the potential damage to his career. Similarly, Seiroku Kajiyama from the Obuchi faction also appar­ ently declined to take the post. The position eventually went to Hikaru Matsunaga, an LDP stalwart who otherwise had no experience in financial matters. 5. Done properly, the bureaucracy could, in fact, be challenged and a political career enhanced, as Naoto Kan showed. The bureaucrats in the Ministry of Health and Welfare had permitted the import of untreated blood long after they knew that it could spread the HIV virus. When victims demanded an explanation of what happened, the Ministry

252

Notes

stonewalled. Shortly after taking office in the Hashimoto government, however, Kan, the new health minister, exposed the practices, bringing scorn to the bureaucracy and trans­ forming himself into something approaching a national hero.

CHAPTER 14 1. The three who did were Keiichiro Hirata, Kikuzo Watanabe and Sumio Hara. Hirata served during the occupation; Watanabe and Hara immediately after the occupa­ tion. 2. Ozaki had been both a deputy budget examiner (shusa), assistant director (kacho hosa), and director of the documentation section (bunsho ka) in the Budget Bureau, all traditional posts on the way to vice minister. In his second career, he would become governor of the People’s Finance Corporation. 3. Ogawa entered the MoF in 1962. In his early career, he spent time in the Budget Bureau. Other than the usual tour as head of a local tax office, Ogawa had no tax experience until appointed assistant director of the First Tax Division (income and other direct taxes) in 1973. He would spend most of the remainder of his career in the tax area. 4. Ishizaka served as a deputy director of the legislation section, deputy budget ex­ aminer (shusa), and director of the investigation section of the Budget Bureau. His ap­ pointment as shingikan in 1989 was his first post in the Tax Bureau. 5. A member of the class of 1966, Nagano became the head of the coordination section in the Tax Bureau. The coordination section (somu ka) coordinated with other bureaus and with the Tax Advisory Council. The section drafted tax reform legislation. 6. Ozaki served as administrative aide to Prime Minister Suzuki. 7. Ishizaka became an aide to Takeshita in 1982, ultimately serving more than two years. Atsushi Nagano assumed the position in 1985, Ogawa a year later. 8. Ohira announced the need for “ additional public responsibility” in the area of fiscal reform in a speech given on September 3, 1979 to the Diet. The language was code for a consumption tax. 9. In part, Ozaki had to remain in the position. Slotted to take Mizuno’s place as head of the Tax Bureau, he could not be promoted until Mizuno moved to the National Tax Agency Administration. That, in turn, depended upon the progress of the consump­ tion tax. 10. For example, he called for the appointment of two or three parliamentary vice ministers and four to six parliamentary councilors. They would be expected to develop expertise and engage in policy formulation. See Ichiro Ozawa, Blueprint fo r a New Japan (1994), 57. He wanted politicians rather than bureaucrats to answer questions in the Diet and to have ministers appointed on the basis of ability rather than seniority. Id., 58-59.

CHAPTER 16 1. This is roughly the structure for the insurance industry. The industry was a de­ partment within the Banking Bureau. The head of the office was a bucho, someone with a rank equivalent to deputy director general. 2. Nishimura probably has some hope and some chance of becoming vice minister. Promotions from the Banking Bureau were uncommon but they did occur. During his

Notes

253

first year in office, however, he no doubt realized that he had become too controversial to be promoted and could therefore take actions without concern about his career in the MoF. 3. For example, the model has become common in emerging markets. Russia, Ukraine, Moldova, Armenia, Uzbekistan and Kazakhstan have, among others, opted for this model.

CHAPTER 17 1. Mutsuhido Yamaguchi, who became administrative vice minister in the 1980s, held the post for eight years, apparently a record.

Interview s

Some of the people on the list were interviewed in connection with my earlier book, Opening Japan’s Financial Markets. Information gathered from these earlier discussions was, however, also used in this project. Given the more sensitive nature of the second effort, it should be noted that those interviewed the first time around did not necessarily approve or seek to lend themselves specifically to a book about the Ministry of Finance. Indeed, some specifically asked not to be interviewed in connection with this book, although that attitude was rare. Makoto Utsumi, the former international vice minister, represented an example of a person in this category. Inclusion in this list, therefore, should not suggest consent to or approval of this particular project. In addition, some of those contacted for this book were not interviewed personally but instead provided comments on various chapters or other written material. Often, they provided their views by e-mail message or in a letter. This has been noted where relevant. Finally, in one or two rare instances, people interviewed asked not to be listed in the book. This almost always involved officials still in the bureaucracy or private-sector financial institutions. When asked, I acceded to this request. Positions of listed officials are those most relevant to the book. To the extent a city was not identified, this usually signifies an interview by telephone. Abbott, John. Attache, Tokyo, Japan, Department of the Treasury. October 1991. Aikawa, Hiroshi. Nippon Life Insurance Company. August 1997. Arkin, Stanley. Arkin Schaffer & Kaplan. September 1996. Beplat, Tristan. SCAP; Manufacturers Hanover. March, June, and October 1991; Jan­ uary and March 1992. Chino, Tadao. MoF. Tokyo, August 1997. Dallara, Charles H. Department of the Treasury. New York, November 1991. Deguchi, Haruaki. Nippon Life Insurance Company. Tokyo, March 1992 and August 1997. Diehl, William W. SCAP; Department of the Treasury. May 1992. Fauver, Robert C. Department of the Treasury. June 1992.

256

Interviews

Funakoshi, Takehiro. MoF. Tokyo, March 1992. Furukawa, Motohisa. House of Representatives, Japanese National Diet. Tokyo, Au­ gust 1997. Goto, Keizo. MoF. Washington, D.C., 1991-1992; Tokyo, August 1997. Hadley, Eleanor M. SCAP. October 1991. Hironaka, Wakako. House of Councilors, Japanese National Diet. Tokyo, August 1997. Iguchi, Toshihide. Daiwa Bank. August and September 1997. (by mail) Inagaki, Mitsutaka. MoF. Washington, D.C., September 1996. Inouye, Minoru. Bank of Tokyo. Tokyo, March 1992. Itoh, Seishichi. Bank of Tokyo. Tokyo, March 1992. Iwakuni, Tetsundo. House of Representatives, Japanese National Diet. Tokyo, August 1997. Izumi, Shigeyuki. Japanese Communist Party. Tokyo, August 1997. Kanda, Hideki. University of Tokyo. Tokyo, March 1992. Kashiwagi, Akiko. Washington Post. Tokyo, August 1997. (by e-mail) Kashiwagi, Yusuke. Bank of Tokyo/MoF. Tokyo, March 1992 and August 1997. Kato, Takatoshi. MoF. Tokyo, March 1992. Kimura, Yuji. Industrial Bank of Japan. Tokyo, March 1992. Komori, Yoshihisa. Sankei Shimbun. Washington, D.C., September 1996. Kondo, Tetsuo. House of Representatives, Japanese National Diet. Tokyo, August 1997. Koyama, Yoshiaki. MoF. Tokyo, March 1992. Kubota, Manae. House of Councilors, Japanese National Diet. Tokyo, August 1997. Loughran, John (Jack) F. Morgan Guaranty, numerous occasions, 1992-1997. Machol, Margot E. Department of the Treasury. October 1991. Maehara, Yasuhiro. Bank of Japan. Washington, D.C., September 1993. Mano, Teruhiko. Bank of Tokyo. Tokyo, March 1992. Matsumura, Tomokuni (Tom). First Interstate Bank. Denver, August 1991. Matsuno, Nobuhiko. MoF. July 1997 and January 1998. (by e-mail) McCamey, William. Department of the Treasury. February 1992. Miyazawa, Yoichi. MoF. New York, November 1991. Mulford, David C. Department of the Treasury. Washington, June 1992. Munk, Russell. Department of the Treasury. Interview, June 1992; written comments, 1997. Muto, Haruo. Bank of Tokyo. Tokyo, March 1992. Naito, Masahisa. MITI. Washington, D.C., May 1994. Nakamura, Shuzo. MoF. New York, September 1996. Nishida, Takeshi. House of Representatives, Japanese National Diet. Tokyo, August 1997 Nishimura, Yoshimasa. MoF. September 1997. Nishimura, Yoichi. Asahi Shimbun. Moscow, June 1994. Nishimura, Yoko. Fuji Television. Moscow, June 1994 & Tokyo, August 1997. Niu, Masao. Citibank. Tokyo, March 1992. Nunami, Tadao. Bank of Japan. Washington, D.C., 1992 & Tokyo, August 1997. Oba, Tomomitsu. MoF. Tokyo, March 1992. Ogata, Shijuro. Bank of Japan. Tokyo, March 1992 & August 1997. Olson, Chuck. Financial adviser, Internet start-up companies. June & July 1998. Osugi, Kazuhito. Bank of Japan. Tokyo, March 1992.

Interviews

257

Rapp, William V. J.P. Morgan; Bank of America; Department of Commerce. Novem­ ber 1991. Regan, Donald. Secretary of the Treasury. April 1992. Sakaguchi, Akira. Japanese Communist Party. Tokyo, August 1997. Sakai, Takanori. House of Representatives, Japanese National Diet. Tokyo, August 1997. Sexton, David. Yamaichi International (America). New York, September 1996. Shibata, Tatsufumi. MoF. Tokyo, August 1997. Shiozaki, Yasuhisa. House of Councilors, Japanese National Diet. Tokyo, August 1997. Sprinkel, Beryl W. Department of the Treasury. October 1991; February 1992. Sumio, Hiroshi. Citibank. Tokyo, March 1992. Suzuki, Gengo. MoF. Tokyo, March 1992; Washington, D.C., March 1993. Suzuki, Hideo. MoF. Tokyo, March 1992. Takada, Teruo. Federation of Bankers Association of Japan. Tokyo, March 1992. Takeda, Yoshikazu. Nippon Life Insurance Company. Tokyo, August 1997. Takata, Ryouichi (Roy). Bank of Tokyo. June 1992. Tanami, Koji. MoF. September 1997. Written comments on Chapter 13. (by mail) Tatsuuma, Fujio. Mitsubishi Bank. Tokyo, March 1992. Terasawa, Yoshio. House of Councilors, Japanese National Diet. Tokyo, August 1997. Toba, Osamu. J.P. Morgan. January & February 1992. Torii, Osamu. Citibank. Tokyo, March 1992. Toyama, Haruyuki. Bank of Japan. Tokyo, March 1992. Umezono, Tatsuo. Citibank. Tokyo, March 1992. Usuki, Masaharu. Long Term Credit Bank. Tokyo, March 1992. Utsumi, Makoto. MoF. Tokyo, March 1992. Vojta, George J. Citibank; Bankers Trust. New York, July 1991. Watanabe, Masahiro. Industrial Bank of Japan. Tokyo, March 1992. Watanabe, Takeshi. MoF. Tokyo, March 1992 & August 1997. Weadock, James J. Citibank. Tokyo, March 1992. Wriston, Walter B. Citibank. New York, July 1991. Yamada, Osamu (Sam). Mitsubishi Bank; Bank of California. San Francisco, July 1991. Yamamoto, Kenzo. Bank of Japan. Tokyo, March 1992. Yamamoto, Shigeru. Industrial Bank of Japan. Tokyo, March 1992. Yano, Kazuyuki. MoF. New York, September 1996. Yashiro, Masamoto. Citibank. Tokyo, March 1992. Yokota, Tadashi. Dai-Ichi Bank. Tokyo, March 1992. Yoneda, Yasuharu. Industrial Bank of Japan. New York, July 1991. Yoshida, Tatsuo. Industrial Bank of Japan. March 1992. Yoshizawa, Kenji (Peter). Bank of Tokyo. Tokyo, March 1992. Yuasa, Hiro. Sankei Shimbun. Washington, D.C., September 1996.

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Index

Abe, Shintaro, 81 Abekawa, Sumio, 120 Administrative guidance, 3, 32-33, 3846, 87, 134, 242; benefits, 41; constant contact, 39; decline in, 218-219; Euro­ market in, 63-64; informality, 39-40, 112-113, 124-126, 233-234; interest rates, government bonds, 65-66; need for, 40; reform of, 233-234 Administrative vice minister, 7, 18, 19- ' 20, 23, 30, 75-76, 88, 89, 90, 166, 167, 176, 183, 201, 206, 207, 209, 225, 236; early resignation of, 12; of Ministry of Agriculture, 137, 140; pro­ motions from Banking Bureau, 20; promotions from Budget Bureau, 153; promotions from International Finance Bureau, 246; promotions from National Tax Agency Administration, 20, 246; promotions from Office of Cabinet Councillors, 20, 246; promotions from Securities Bureau, 77, 246; promotions from Tax Bureau, 20 Advancement: lockstep, 17; role of scan­ dal, 40; seniority, 17 Aging population, 194, 198 Agricultural Cooperative Law, 132

Agricultural cooperatives, 12, 68, 106, 132-138, 141-143, 169 Agriculture, Forestry and Fisheries, Min­ istry of, 12, 132-133, 136-138, 140, 141, 177, 240, 250 Amakudari, 3, 32-38, 51, 76, 90, 97, 155156, 157, 237; ceremonial posts, 37; decline in, 219; jusen, 131; limits, 3638, 247; political influence over, 176; problems associated with, 37; Secretar­ iat, role of, 34; securities industry, 7576, 88-90, 246; zaibatsu banks, atti­ tude of, 35, 37 Amalgamations, of banks. See Consolida­ tions, of banks Anti-consumer policies, 6-7, 12, 50, 68, 72, 129, 161, 169 Anti-Monopoly Law, 225 Anzen Credit, 106, 109, 138-139 Apostasy, 238-239 Arai, Shokei, 248 Article 65 of Securities and Exchange Law, 67, 83-84 Asami, Toshihiko, 173 Asia, x Asset management, 50, 87, 96, 217 Assistant director, 22, 26, 44, 153

264

Index

Association of Regional Banks, 249 ATM machines, 7, 41, 216, 242 Auditing Agency, 26, 156-157 Automobile Weight Tax, 186-187 Bad loans, 13, 93-94, 100, 105-108, 110, 112, 126-127, 139, 216 Bailout, of banks. See Rescues of banks Bank Act of 1890, 94-95 Bank of America, 58 Bank of Japan, 10, 20, 39, 41, 50, 55-57, 65, 72, 75, 81, 95, 97, 101, 103-104, 107, 109, 139, 140, 152, 155, 165166, 174, 183, 185-186, 197, 217, 233, 247 Bank of Japan Law, 174-175 Bank of Kobe, 96 Bank of Taiwan, 95 Bank of Tokyo, 35, 38, 43, 50, 62-63, 87, 162, 219, 248 Bank of Yokohama, 35, 200 Bankers Trust, 117 Banking Bureau, 20-24, 41^14, 49-52, 65, 80, 83-85, 90, 91, 93-111, 113, 116, 119-128, 129-144, 163, 184-185, 190, 219, 224-227, 231-232, 235-236; conflict with Securities Bureau, 84-85; creation, 49, 94; crisis management, 5759; divisions within, 89, 135; interest rates, deregulation, 67-68, 144; les­ sons, 94; occupation period, 248; over­ sight function, 52 Banking Law of 1927, 57, 95, 108, 227 Big bang, 215 Big Four, 71, 76-79, 84-86, 90 Bonds: bank issuance of, 42; Euro, 80; government (see Government bonds); trustee of, 74 Branch license, foreign, 30 Branch network, 42, 49, 61, 98, 100, 101, 114, 162, 218; decline in importance of, 68, 104; overseas, 62-64, 119, 124 Bridge banks, 228, 230 Bubble economy, 3, 93, 102-105, 112, 134 Budget, 9, 93, 149-153, 205-206, 231232, 240-241, 243; balanced, 10, 18, 77, 150, 152, 157, 195, 197, 207, 229,

238; deficits, 10, 12, 195-200; general account, 17; MoF influence, 49, 220; political influence, 177-179; process for determining, 151-152; reform of process, 240-241, 243; supplemental, 152, 196 Budget Bureau, 19, 21-23, 25, 30, 35, 65, 89, 106, 125, 137, 149-159, 167168, 179, 182, 184-185, 187, 194, 195, 199, 201, 212, 225, 231, 236, 240241, 243, 246 Budget examiner, 153-154, 210 Bukai, 163, 165-166, 174, 175 Bullet train, 149, 154 Bunsho ka. See Secretariat, Documenta­ tion Section Bureaucratic power, 6; fa9ade of, 6 Bureaucracy: arbiter of disputes, 6, 161— 165; consensus-building role, 6, 160, 161, 169, 220; held in high esteem, 11; independence, 11; need to update, xi; political intervention, 5-7, 181— 192 Bureaucratic state, 2 Bureaus, 18, 21-24 Cabinet Councilors, Office of, 20, 246 California, 63 Call reports, 117 Capital: banks, 49, 95; guaranteed supply of, 52-53; key industries, 55; shortage of, 50, 52, 60 Capital Market Promotion Foundation, 36, 88 Capital Market Research Institute, 36, 88 Career officials, 17 Catalyst, for change, 33 Cayman Islands, 118 Ceilings, on spending, 17, 150-153, 157, 184, 197, 220 Central Bank. See Bank of Japan Central Bank Study Group, 174 Certificates of deposit, 67-68 Chase Manhattan Bank, 58 Chino, Tadao, 22 Chuo Trust Bank, 50 Citibank, 58, 83, 217 Citicorp, 83

Index City banks, 42, 50, 56, 67, 73, 84, 100, 101, 114, 162, 217 Coalition government, 138, 174, 188, 194 Colonization, 26, 39, 155-157 Command economy, 59 Commissions, brokerage, 86-87, 91 Community Reinvestment Act, 242 Compartmentalization, 1, 2, 30, 41, 62, 67, 69, 74, 81-85, 87, 93, 96, 129, 143, 162, 164, 242 Compensation scandal, 71, 85-86, 87, 163, 224, 248 Competition, 61; limited, 59; reckless, 49 Consensus, xi, 7-8, 10, 43, 59, 69, 80, 85, 161-163, 165, 175, 220, 229, 240, 243 Consolidations, of banks, 97-99; mergers, 57, 87, 98-102, 228; occupation dur­ ing, 96; “ One Prefecture, One Bank,” 96; pre-war, 95-96; resistance to, 51 Consolidation, of securities firms, 73, 75 Consumers, 9, 45, 72, 161, 216, 220221, 230, 242 Consumption tax, 22-23, 189, 193-194; increases in, 207-212; need for, 194198; prime minister killer, 194, 198— 207 Constitution, 150 Construction, Ministry of, 34, 177, 240 Convoy system, 6, 93, 238 Coordination Section, 26 Cosmo Credit, 103-104, 108, 127, 234235 Cosmos Securities Co., 87 Credit cards, 6 Credit shortage, 1 Customs and Tariff Bureau, 21, 76, 190; International Affairs Division, 25 Dai-Ichi Bank, 96, 98 Dai-Ichi Sogo. See Taiheiyo Bank Daiwa Bank, 13, 50, 87, 91, 97, 130, 142, 190, 217, 226, 231, 234, 236; trading loss, 113, 115-117, 121; unique position in financial markets, 114 Daiwa Securities Co., 72

265

Daiwa Trust Bank Company, 114, 115, 117, 120 Debentures, 63, 72 Debt, corporate, 77 Decompartmentalization, 69-70, 86-87, 143, 164, 226 Defense spending, 7, 181, 189 Democratic Party, 221 Denmark, 58 Deposit insurance, 57, 95, 100, 103-104, 109 Deposit Insurance Corporation, 104, 106— 108, 138, 249 Depositors, 93, 100, 129 Deposits, 42, 54-55, 62, 64, 67, 132133, 217, 218 Deputy budget examiner, 26, 153-154, 155, 158, 178, 232, 240, 241 Deputy director. See Assistant director Deputy director general, 25-26, 28, 44, 89, 122, 125, 153, 200, 201 Derivatives, 9, 77, 231 Destabilizing, 41, 59, 95 Diet, 9-10, 25-27, 44, 73, 79, 86-87, 106, 130, 136-137, 139, 141-143, 149, 154, 155, 157, 160, 163, 165167, 191, 201, 205, 206, 208, 209, 220, 241 Director general, 10, 21, 30-31, 44, 73, 79, 89, 102, 137, 141, 153, 154, 168, 182, 226, 231, 238 Discount window, 50, 55 Discretion, legal, 95 Dissent, 27, 230, 238-239 Division director, 22, 25-26, 28, 157 Dodge, Joseph, 54-55 Dodge Line/Plan, 54, 65 Dollars: access to, 62; need for, 52 Economic models: Japanese, x, xi, 243; U.S., x Economic Planning Agency, 26, 125, 156, 225 Economic transition, x Economist magazine, 150 Ehime Prefecture, 104 Embarrassment, of bureaucrats, 8-9, 45, 113, 125, 226, 239

266

Index

English: exposure to, 21; need for during occupation, 246 Entertainment, of bureaucrats, 46, 129, 139, 209, 233 Environmental Agency, 156, 201 Equal Credit Opportunity Act, 242 Equal treatment, of banks, 56 Equity offerings/financing, 50, 72 Europe, 62, 83 Euromarket, 63 Euromoney, 188, 191 Euroyen Market, 21 Examination, National Public Service, 19, 24, 238 Examiners, bank, 29, 41, 109, 115, 120, 123, 124, 233, 249 Experience, 8, 89, 125, 219, 231-233 Expertise, 28, 45^16, 90, 212, 227, 231233, 236 Export-Import Bank of Japan, 35, 185, 190, 200 Exports, 52 Failures, banks, 69, 99-102; avoidance of, 94; jusen, 130, 134-138 Fair Trade Commission, 39, 57, 155 Farm banks. See Agricultural coopera­ tives Federal Deposit Insurance Corporation, 115, 124 Federal Reserve Board, 113, 115, 117— 122, 124, 126 Federation of Bankers Association, 37, 39, 80, 142, 165 Fifth High School, 183 Finance Minister. See Minister of Finance Financial Issues Research Council, of LDP, 251 Financial Planning Bureau, 22, 224, 226227 Financial Supervisory Agency, 22, 224225, 228, 230 Financial System Research Council, 81, 84, 140, 174, 250 Financial System Stabilization Commit­ tee, 140-141, 144 First Boston, 58 First Higher School (Ikko), 245

Fiscal conservatism, 9, 12, 18, 195 Fiscal Policy Council, of LDP, 251 Forbearance, 94, 104-110, 137, 235-236 Foreign Affairs, Ministry of, 183, 204 Foreign Bank Supervision Enhancement Act, 115 Foreign banks, 56-57, 67-68, 82-84, 163 Foreign exchange: controls, 2; importance of, 53; policies, 17 Foreign Exchange Control Board, 57 Foreign firms, 36, 217 Foreign governments, 67 Foreign influences, 8, 217 Foreign pressure. See Gaiatsu Fuji Bank, 82, 96, 142 Fujii, Hirohisa, 210 Fujita, Akira, 117, 118, 120, 122 Fukuda, Yukihiro, 201 Fukuda, Takeo, 97, 167, 173, 182, 184186, 187, 196, 199, 202, 251 Fukuoka, 205 Funayama, Masamikichi, 246 Fushiya, Kazuhiko, 231 Fuso Bank, 102 Gaiatsu, 78, 81-84, 163-164, 199 General Council, of LDP, 174, 179 Generalists, within MoF, 40 Gensaki market, 68 Germany, 83, 209 Glass-Steagall Act, 73 Goko. See Fifth High School Goldman Sachs, 36 Government bonds, 17, 61, 65, 72, 8081, 113-118, 152, 196-197, 200, 208. See also Syndicate, government bonds Great Britain, 25, 83-85 Green card, 29 Guarantees, implicit by government, 49 Gyosei shido. See Administrative guid­ ance Gyoten, Toyoo, 22, 84, 219, 236 Hamaguchi, Katsuhiko, 35 Hamamoto, Eisuke, 204 Hamanaka, Hideichiro, 225 Hanwa Bank, 108

Index Hara, Sumio, 35, 252 Hashiguchi, Osamu, 167, 187 Hashimoto, Ryogo, 245, 250 Hashimoto, Ryutaro, 88-89, 139, 176, 189-191, 211, 215, 224, 245, 247, 251, 252 Hashimoto, Toru, 142 Hatoyama, Ichiro, 172 Hatoyama, Kunio, 172, 205 Hatoyama, Yukio, 172 Health and Welfare, Ministry of, 251 Heiwa Sogo Bank, 49, 100-101 Hidaka, Sohei, 204 Hirasawa, Sadaaki, 22, 84, 102, 246 Hirata, Keiichiro, 252 Hisho ka. See Secretariat, Personnel Sec­ tion Hokkaido, 205 Hokkaido Development Agency, 156 Hokkaido Takushoku Bank, 109-110, 127, 130 Home Affairs, Ministry of, 181, 188, 240 Hong Kong, 233 Hosokawa, Morihiro, 137, 184, 189-190, 192, 208-211, 222 Hosomi, Takashi, 22 Hotel Okura, 154 Housing Loan Administration Coopera­ tion, 142 Housing loan companies. See Jusen Hyogo Bank, 38, 102, 107, 249 Hyogo Prefecture, 96 Ichimada, Hisato, 151, 183 Iguchi, Toshihide, 115-116, 119-121, 250 Ihara, Takashi, 35 Ikeda, Hayato, 18, 79, 171, 181-185, 196, 200, 204, 223 Ikeda, Mitsue, 173 Ikeda, Yukihiko, 173 Imperial Navy, 79 Imperial Ordinance, 150 Inamura, Koichi, 22 Income doubling plan, 151, 183 Industrial Bank of Japan, 7, 74, 142 Industry, 41, 94, 104, 161, 165, 169; con­

267

sensus development, 162, 175; warrelated, 96 Inflation, x, 53 Information flow, to bureaucrats, 33 Initiative, discouraged, 18, 27 Inoue, Kaoru, 99 Inspection agencies, 149, 156 Inspections, financial, 29, 89-90, 11 fi­ n e , 131, 234 Inspectors, tax, 41 Instability, financial, 94 Institute of Fiscal and Monetary Policy, 176 Insurance, 17, 217, 231, 252 Interest rates, 2, 6, 50-51, 55, 58, 102, 198; deregulation of, 61, 64, 67-69, 83; Japan premium, 64, 94, 113, 136; pay­ ments foregone, 136 Interior, Ministry of, 57 International Finance Bureau, 17, 21, 80, 89, 122, 190, 226, 232, 238, 246 International impetus, 25, 62-64 International Monetary Fund, 58 International Trade and Industry, Ministry of. See MIT1 International vice minister. See Vice min­ ister for international Affairs Ishibashi, Tanzan, 183 Ishida, Tadashi, 246 Ishino, Shinichi, 183-184 Ishizaka, Masami, 201, 206, 252 Iwate Prefecture, 205 Iyo Bank, 104 Izui, Junichi, 176 Japan Development Bank, 35 Japan Premium. See Interest rates Japan Renewal Party. See Shinseito Japan Securities Dealers Association, 36-37, 247 Japan Securities Exchange, 72 Japan Securities Investment Advisors As­ sociation, 36 Japan Telegraph and Telephone, 197 Japan Tobacco and Salt, 77, 197 Japanese National Railways, 77, 197 Jimu jikan. See Administradve vice min­ ister

268

Index

Joint Securities Corporation, 75 Jonan Shinkin, 218 Jusen, 3, 24, 38, 123, 130-145, 151, 160, 169, 190, 219, 222-223, 226, 235 Kacho. See Director general Kacho hosa. See Assistant director Kaifu, Toshiki, 86 Kajiyama, Seiroku, 252 Kakari-cho. See Section chief Kakari-in. See Sub-section chief Kaku-Fuku Wars, 187 Kakudo, Kenichi, 140 Kan, Naoto, 251-252 Kaneko, Ippei, 201 Kanemaru, Shin, 168 Kansai Sogo, 249 Karuta Kai, 34 Kashiwagi, Yusuke, 21-22, 247 Kasumigaseki, 3 Kato, Koichi, 135, 175 Kato, Takatoshi, 22 Kazakhstan, x Keio University, 239, 246 Kimura, Kozo, 121 Kishi, Nobusuke, 183, 193, 251 Kleinwort Benson, 36 Kogayu, Masami, 167 Koizumi, Tadayuki, 251 Komeito, 207 Komiyama, Eizo, 100 Komura, Takeshi, 29, 176, 237 Kono, Ichiro, 223, 251 Kono, Michikazu, 81 Konoike Bank, 96 Kopeks, x Kubota, Isao, 190 Kuhn Loeb, 58 Korean War, 55 Kubo, Wataru, 191 Kumamoto Sogo, 102 Kurosawa, Yo, 142 Kyokucho. See Director general Labor, low-cost, 53 Law Concerning Debenture Issues of Bank, 55 Lead bank, 56

Lead commissioned bank, 74 Leadership: bureaucratic, 12, 30-31, 224, 230; by politicians, 193-194, 198-199; reform, 235-237 Leaks, 40, 75, 88, 99, 84, 129, 141, 233, Liaison Office, within MoF, 246 Liberal Democratic Party, 1, 4-6, 11-12, 79-80, 110, 135-141, 143, 150, 160163, 165-168, 172-179, 184, 186, 189, 191-192, 202-211, 216, 220, 222-228, 230; constituencies, 5, 12, 30, 164, 165, 166, 199, 205, 220-221; factions, 5-6, 11, 166, 167, 201-202, 204, 206, 209; monopoly of power, 6; secretary general of, 174 Liberal Party, 183 Lifetime employment, 1 Limitations, on banks, 51 Loan priority system, 52-53; coal, 53-54; electricity, 53-54 Loans: balance of payment, 58; Euromar­ ket, 63-64; long-term, 55, 63; lowinterest, 55; pre-occupation, 96; real estate, 45, 134; short-term, 50 Local tax office, 26 London, 59, 62-63, 77 Long Term Credit Bank, 125 Long-term credit banks, 50, 61, 68, 86, 87, 97, 126 Lottery, for deposits, 218-219, 242 Loyalty, of retired bureaucrats, 36 Maekawa, Haruo, 185, 251 Maeo, Shigesaburo, 183, 200, 245 Mainichi Shimbun, 103 Makabe, Minoru, 218 Manabe, Takenori, 136 Management and Coordination Agency, 26, 156-157 Marriages, between bureaucrats and poli­ ticians, 172-173 Maru se, 179, 181 Matsukawa, Michiya, 22, 36 Matsunaga, Hikaru, 251 Matsuno, Nobuhiko, 89 Matsushita, Yasuo, 152 Meiji Restoration, 17 Merrill Lynch, 217

Index Middle East, 63 Midori Bank, 104 Mieno, Yasushi, 104 Miki, Takeo, 200 Minister of Finance, 18-19, 26, 38, 139, 179, 183, 185, 189, 191, 201, 204, 206, 210 Ministry of Finance, 174; break-up of, 72; changed role of, 69; classes, 24-25; family, within, 137, 184, 207, 209, 211, 236; late hours, 26; punishment of, 223-224; reform of, 216-221, 222228, 229-244; studying abroad, 25-26; work ethic, 27 MITI, 131, 135, 163, 183, 186, 204, 240, 242 Mitsubishi Bank, 35, 38, 63, 87, 96, 9899, 219 Mitsubishi-Bank of Tokyo, 38, 110, 217 Mitsui Bank, 38, 96, 219 Mitsuzuka, Hiroshi, 172, 176, 251 Miyazawa, Kiichi, 34, 172, 183, 200, 204, 208 Miyazawa, Yoichi, 172 Mizuno, Masaru, 22, 201, 203-204, 206, 252 Mizuta, Mikio, 58 MoFTan, 42-46, 76, 126 Moral hazards, banking, 93 Morgan Guaranty, 44, 78 Morgan Stanley, 36, 58 Mori-Ishi line, 183-185 Morinaga, Teiichiro, 74, 81, 183-184, 251 Mother banks, 131, 136 Multimember districts, 6 Multiparty system, 6 Murakami, Isamu, 251 Murakami, Kotaro, 185-186 Murayama, Tomii, 188-189, 191, 211 Muto, Toshiro, 246 Mutual funds, 17 Nagaoka, Minoru, 88 Nagano, Atsushi, 201, 206, 252 Nagata-cho, 4 Nakagawa, Koji, 79 Nakahira, Kosuke, 22

269

Nakasone, Yasuhiro, 79, 82, 164, 171, 181, 202-206 National Defense Agency, 156-157 National Land Agency, 156, 187 National Personnel Authority, 26, 156— 157 National Tax Agency Administration, 20, 35, 73, 85, 168, 207, 227, 248 New Frontier Party. See Shinshinto New York, 58-59, 62-63, 77, 83, 116, 117, 118, 120, 125, 226, 234 New York Banking Department, 115 Newly Independent States, ix, x Nihon Keizai Shimbun, 88 Nikkei Average, 74, 84 Nikko Securities Co., 72, 86, 126, 217, 248 Nippon Credit Bank, 50, 126 Nippon Housing Loan Company, 131 Nippon Kangyo Bank, 99 Nishi-Nippon Sogo, 102, 249 Nishimura, Yoshimasa, 94, 104—109, 117— 118, 121-123, 125, 130, 137-140, 142144, 190, 216, 226, 235-236 Niwayama, Keiichiro, 131 Noda, Takeo, 251 Noda, Takeshi, 251 Nomura Bank, 72 Nomura Research Institute, 36, 79 Nomura Securities Co., 72, 75-76, 78, 81, 84-87, 90-91, 120-121 Nonbanks, 135 Non-career officials, 25, 29, 247 Norinchukin Bank, 132, 137, 140 North Korea, 55 Novel practices, 41 Oba, Tomomitsu, 21-22, 82, 235 Obuchi faction, 251 Ochi, Michio, 173 Occupation, 13, 72, 96, 161, 194, 196, 232 Ogawa, Tadashi, 89, 142, 201, 206-207, 209, 210, 246, 252 Ohi Securities Co., 75 Ohira, Masayoshi, 81, 167, 173, 183, 198202, 206, 251 Ohta, Takeshi, 36

270

Index

Oil crisis, 59, 60, 64-65, 69, 152, 186, 188, 196, 199 Okawara, Taichiro, 135 Okinawa Development Agency, 156 Okumura, Tsunao, 79 Okura, Masataka, 200, 246 “ Old boys,” 10, 20, 24, 88-90, 236 Operating hours, for banks, 41 Opposition parties, 6, 12, 141, 150, 166, 178, 194, 202, 205, 216, 220, 222 Osaka, 96, 100, 201 Overseas activities, by banks, 50 Overseas Economic Cooperation Fund, 35, 190 Ozaki, Mamoru, 201, 204, 206, 246, 252 Ozawa, Ichiro, 168, 176, 189, 208-211, 220, 252 Panic, 94-95, 112, 127; of 1927, 72, 93, 95, 227 Parliamentary vice minister, within the MoF, 204, 245 Peace Treaty, San Francisco, 62 People’s Finance Corporation, 35, 200, 252 Philosophy, regulatory, 44, 69, 95 Policy Research Council, 163, 166, 173— 175, 178-179, 204 Politicians, 4-7, 26, 61, 135, 139-140, 142, 144, 145, 149-150, 154, 160-170, 197, 209, 212, 219-221, 222; disdain by bureaucrats, 7; influencing budget, 177-180, 183-184, 186-188, 243; in­ tervention by, 79, 130-131, 157-158, 171-192, 238; role in juseti bailout, 135, 141-142; ties with bureaucrats, 4, 171-177, 180 Postal Savings System, 121, 132, 163 Posts and Telecommunications, Ministry of, 10, 121 Postwar economic system, xi, 1, 2, 8, 52, 72, 74, 112, 144, 216, 223, 225, 241, 243, 244; administrative guidance, role of, 41; double-digit growth, 50; unrav­ eling of, 2 Postwar financial system, 4, 37-38, 55, 61, 64, 69, 81-82, 84, 86, 101, 108, 229, 230

Postwar political structure, 9, 220 Press, 12, 88, 122, 129, 131, 141, 144145, 193 Prime minister, 66, 73, 81, 151, 164, 166, 184, 193, 196, 200, 203, 208, 212, 216, 222, 225 Promotions, within bureaucracy, 20, 27, 31, 167, 236, 237, 239 Property market, 12 Public Finance Law, 151, 154, 158, 196 Public offerings, 74 Public works, 7, 65 Ranking, of banks, 42, 56 Reconstruction Finance Bank, 53-54 Recruit scandal, 79, 207 Regional banks, 63, 104, 126 Representative offices, of banks, 62-63 Rescues, of banks, 49, 93 Research Committee on Finance and Banking Systems, of LDP, 174 Reserved seats, 35, 190 Reserves: banks, 57, 95; foreign, 49, 52, 57-59, 60 Resolution and Collection Bank, 106, 109 Resolution Trust Company (U.S.), 108, 216 Retail banking, 9 Retribution, 41, 223-224 Risk, 13, 30, 69, 90, 91, 103, 127, 131, 134, 141, 143, 163, 226, 236; allevia­ tion of, 55, 217; aversion to, 28-29, 40, 81, 230; Euromarket, 63; mini­ mized, 59; need to promote, 237-238 Rituals, 43 Rotation, 27-28, 45, 155, 230-232, 237, 241; blame avoidance, 29; “ one year, one job,” 27; rapid, 18, 91, 125, 163, 231 Rubin, Robert, 122, 190 Run (on bank), 13, 100, 103-104; pre­ war, 95 Sagami, Takehiro, 22, 246 Saitama Bank, 96 Saitama Prefecture, 96 Saito, Jiro, 23, 137, 152, 153, 173, 176, 184, 189-191, 209-211, 219, 236

Index Sakai, Takanori, 251 Sakakibara, Eisuke, 7, 22, 24, 31, 122, 167, 176, 190, 236-239 Sakamaki, Hideo, 87 Sakigake, 138-139, 143, 189, 224, 251 Sakura Bank, 108, 219 Sanwa Bank, 96; formation of, 96 Sasaski, Tadashi, 81 Sato, Eisaku, 184, 186, 187, 204 Sato, Ichiro, 185 Scandal, 9, 91, 139, 164, 202, 234 SCAP. See Supreme Commander of Al­ lied Powers Secrecy, 8, 13, 75, 88, 94, 100, 101, 103, 106, 118, 126, 129-130, 139, 141, 144, 216, 229, 234-235 Secret fund, within budget, 179 Secretariat, 11, 25, 30, 51, 90, 137, 156, 182, 201, 210, 211, 212, 239; Docu­ mentation Section, 26, 27-28, 167, 210; Financial Inspection Section, 90; Per­ sonnel Section, 20, 24, 28, 167 Section chief, 26 Securities and Exchange Commission, Ja­ pan, 39, 73 Securities and Exchange Commission, U.S., 126 Securities and Exchange Council, 81, 84 Securities and Exchange Law, 67, 72 Securities and Exchange Surveillance Commission, 22, 57, 90, 91, 227 Securities Bureau, 21-23, 41, 43-44, 65, 71, 80, 84-91, 129, 201, 224-227; cre­ ation of, 75; divisions in, 26, 89, 90; second-class status of, 76 Securities firms, 68, 84-87, 91, 102, 216; competition with banks, 61, 79-81; im­ portance to MoF, 77; influence of No­ mura, 77, 81; political connections, 10, 79, 86, 87; pre-war, 72; role in recov­ ery, 74; separation from banks, 67, 227 Securities Investment Trust Association, 36 Securitization, 77 Segawa, Minoru, 75 Self-regulatory organization, 36, 39—40, 165 Settai. See Entertainment

271

Shareholders, 73 Shiga Prefecture, 188 Shingikan. See Deputy director general Shinkin, 105, 218 Shinkyo, Takeshi, 108 Shinozawa, Kyosuke, 122, 138, 142 Shinseito, 208 Shinshinto, 140, 141, 208-210 Shiteiseki. See Reserved seats Showa Denko scandal, 184, 187 Shukeikan. See Budget examiner Shusa. See Deputy budget examiner Socialists, 7, 138-139, 143, 189-191, 198, 205, 208, 210, 211, 224 Socializing, 42, 177 Society of the Friends of MoF, 34 Sogo Bank Law of 1951, 102 Sogo hanks, 100-101, 102, 104 Somu ka. See Coordination Section South Korea, x, 229 Soviet Union, x Special Committee on Financial Prob­ lems, of LDP, 174 Specialization. See Expertise Stability, 93 Status quo, enforcer of, 61 Stock market, 8, 12, 85, 88, 227 Stock exchange, 36; regional, 72 Sub-section chief, 26 Subsidiaries, securities, 84—85, 87 Sullivan & Cromwell, 119 Sumita, Satoshi, 97-99, 140, 141, 185— 186, 190, 246, 249, 251 Sumitomo Bank, 49, 63, 96, 100-101, 121, 246 Summits, international, 20 Superbanks. See Universal banks Supreme Commander of Allied Powers, 53-55, 72, 96 Suzuki, Gengo, 246 Suzuki, Hideo, 36 Suzuki, Zenko, 81, 173, 202, 252 Suzuki & Co., 95 Syndicate: Eurobonds, 80; government bond, 65-67 Tabuchi, Yoshihisa, 79, 87, 91 Tachi, Ryuichiro, 140

272

Index

Taiheiyo Bank, 108 Taiyo Bank, 102 Taiyo-Kobe Bank, 38, 183, 219 Takachiho Sogo, 249 Takagi, Fumio, 173, 186-187, 239 Takahashi, Hajime, 200 Takasaki Paper Company, 185 Takemura, Masayoshi, 122, 139-140, 182, 188-192 Takeshita, Noboru, 44, 78-79, 81, 104, 139, 142, 182, 201, 206-207, 252 Takeuchi, Michio, 88 Tanaka, Kakuei, 97, 152, 167, 171, 182, 186-188, 195-196, 202, 203, 206, 209 Tanami, Koji, 237, 246 Tanimura, Hiroshi, 88 “ Tap on the shoulder,” 34 Tax Advisory Council, 202, 205, 210, 252 Tax Bureau, 21-23, 35, 89, 168-169, 182, 194, 200-207, 210, 223, 225, 232 Tax cuts, 10 Tax revenues, 65, 194-195, 208 Tax shift, within the MoF, 201, 212 Tax System Research Commission, of LDP, 202, 204-205, 210 Teikoku Bank, 96, 98 Temporary Interest Rate Adjustment Law, 55 Teramura, Nobuyuki, 135-136, 141 Thailand, 229 Thirty-Fourth Bank, 96 Three Bureaus Agreement, 80 Three Harmonies. See Sanwa Bank Three principles, 80 Tight money, periods of, 56 Todai. See University of Tokyo Toho Sogo, 104 Tokyo Commerce University, 200 Tokyo International Financial Futures Exchange, 36 Tokyo Kyoda Bank, 109 Tokyo Kyowa, 106, 109, 123, 138-139, 144 Tokyo Stock Exchange? 20, 33, 36-37, 39, 77-78, 83, 165, 183, 247

Toyota, 76 Transparency, 94, 180 Transportation, Ministry of, 177, 240 Treasury Bureau, 21, 39, 51, 187, 201, 246; Bond Syndicate, 65-66, 73, 75; Second National Property Division, 25 Treasury Department, U.S., 21 Tribes. See Zoku Trust banks, 41, 61, 78, 84, 86, 97, 126, 164 Trust companies, 78, 96 Trust department, divestiture of, 97, 162 Trust Fund Bureau, 66 Tsuchida, Masaaki, 132-133, 135-136, 141 Tsuda, Masahiro, 116-118, 120, 250 Tsushima, Juichi, 182, 200 Tsutsumi, Hidetaka, 135, 137 Ueno, Hirofumi, 137 Underwriting, 50, 61, 66, 72, 80, 87 Unions, 220 United States, 25, 62, 68, 78, 82, 85, 109, 124, 164, 183, 190, 242, 243 Universal banks, 62, 87, 216-219, 242 University of Kyoto, 19, 182, 239 University of Tokyo, 17, 19, 42, 76, 182183, 140, 188, 204, 230, 239-240; Diet, 172; economics faculty, 239; law faculty, 24, 237; science/math faculty, 24, 239 U.S. Attorney’s Office, 113, 119 Utsumi, Makoto, 22, 29 Vice minister for international affairs, 7, 18, 20-21, 24, 27, 30, 167, 238; Bar­ barian tamers, 20; table of, 22 Vickers da Costa, Ltd., 83 Vienna, 58 Wakui, Yoji, 137-138, 176, 230 Waseda University, 239 Watanabe, Kiichi, 22 Watanabe, Kikuzo, 252 Watanabe, Takeshi, 239, 245 Whistle blowing, 120 Window guidance, 45, 55-56

Index Women, in MoF: number of, 24, 240, 246; positions held, 25 World Bank, 58 Yamaguchi, Mitsuhide, 253 Yamaichi Securities Co., 57, 60, 72, 7475, 84, 95, 101, 103, 126, 130, 217, 234 Yamaji, Hiroyuki, 116, 122, 250 Yamanaka, Sadanori, 204-205 Yamasaki, Taku, 174-175 Yasuda, Hiroshi, 89 Yasuda Bank, 96 Yen-Dollar Accord, 21 Yen-Dollar talks, 29, 83, 163-164 Yokohama Specie Bank, 35, 62-63, 248

273

Yokohama Tax Office, 200 Yonezato, Hiroshi, 80 Yoshida, Masateru, 107 Yoshida, Shigeru, 183 Yoshida, Taroichi, 22 Yoshikuni, Jiro, 246-247 Youkaichi City, 188 Zaibatsu, 38, 73, 95-96 Zaibatsu banks, 35, 37-38, 57, 73, 9596, 98-99, 219 Zaimukan. See Vice minister for interna­ tional affairs Zenginkyo. See Federation of Bankers As­ sociation Zoku, 175-176

About the Author

J. ROBERT BROWN, JR. is a Professor of Law at the University of Denver College of Law. Before joining the faculty, he practiced law in Washington, D.C., both in private practice and with the Securities and Exchange Commission. He has written a number of books and articles on the financial markets of Japan and the states of the former Soviet Union.

ISBN 1-56720-230-6

90 000> EAN

9 781567 202304 HARDCOVER BAR CODE