Japan's bad debt problem no longer appears insurmountable as it did a year ago, but the government must pick up the pace of bank reform and convince the market that it is serious about disposing of the non-performing loans still sitting in its banks, according to the former head of the U.S.'s Resolution Trust Corp. (RTC).

"The Japanese premium has disappeared, but the world is not yet confident that the government will revitalize the banking system," L. William Seidman told an audience of roughly 500 delegates in the keynote address at the Fabozzi/IMN conference on Real Estate Finance and Securitization in Japan last week.

Drawing on his experience as former chairman of the RTC, which disposed of over $500 billion in assets from failed savings and loans institutions, Seidman voiced several warnings and suggestions for Japanese policymakers.

Regarding the government's plan to grant loans to the biggest 15 banks in exchange for preferred stock, he said that any capital injection into the banking system would be useless if banks did not revamp their current management. "The world will be closely watching the caliber of management insisted on by the government. If [the capital] infusion fails to bring change, it will be extremely difficult for the government to start over again in this effort," he said.

The longer Japan sits on its bad debts, the more costly it will be to clean up in the future, he added. "The way to unfreeze the market is to take the losses and provide full disclosure about what's for sale, and that will get the market going," he said. The danger of setting up an RTC-style agency is that it creates another bureaucracy with a built-in disincentive to the prompt sale of assets, since every sale brings it closer to the end of its mandate. However, countries like Mexico, which held onto its assets instead of selling them promptly, end up increasing the eventual cost to their government, he said.

Until the government takes steps to show that it really means to overhaul its banking sector, Japan stands small chance of recovering from the prolonged recession. An established independent regulator, greater financial disclosure, less concentration in real estate investments and an end to conflict-of-interest lending are some of the "deadly sins" that Japanese banks must eliminate, Seidman said.

"There's nothing to keep a market from performing badly when there's a huge overhang of bad assets in the country," he said. - VC

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